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Modeling Market Entry Mode Choice: the
Case of German Firms in China
Inauguraldissertation zur Erlangung des Grades eines Doktors der
Wirtschaftswissenschaften (Dr. rer. pol.) an der
Fakultät für Wirtschaftswissenschaften der
Universität Bielefeld
vorgelegt von
M.A. Xuemin Zhao
Bielefeld 2005
II
1. Gutachter: Prof. Dr. Reinhold Decker
Fakultät für Wirtschaftswissenschaften
Universität Bielefeld
2. Gutachter: Prof. Dr. Stefan Wielenberg
Fakultät für Wirtschaftswissenschaften
Universität Bielefeld
Tag der Mündlichen Prüfung: 16.12.2005
III
Acknowledgements
My supervisor Prof. Dr. Reinhold Decker deserves my great thanks for his close
guidance, his arduous reading and revising this dissertation, and his pleasant
cooperation. His rigorous attitude toward teaching and research has influenced me
significantly. I want to express my great appreciation to Prof. Dr. Stefan
Wielenberg, my second supervisor, for his insightful questions, interesting
discussions, and helpful comments on the dissertation. I would also like to express
my great thanks to Prof. Volker Boehm, Ph.D. who has always encouraged me to
challenge myself, and who has exerted great effort in finding the students the
financial support to set our hearts at studying and researching.
I want also to show my thanks to Prof. Dr. Herbert Dawid, Prof. Dr. Bernhard
Eckwert, Prof. Dr. Göran Kauermann, Prof. Dr. Walter Tockel for their close
guidance. My improvement on mathematical techniques is due to the help of Chih-
Ying Hsiao, PD Dr. Jan Wenzelburger, Dr. Thorsten Pampel, and Dr. Wenlang
Zhang.
I have enjoyed the pleasant working atmosphere in BiGSEM. I cherish the good
friendship with my colleagues. In particular, I need to thank Evan Shellshear and
Marten Hillebrand for their patience in reading my dissertation and many good
comments and revisions.
I want also to show my appreciation to my parents and girl friend for their
encouragement and patience.
My first two and half years’ study here in Bielefeld were fund by BiGSEM, and
Schüco International supported the rest of my study here in Bielefeld through
BiGSEM.
Finally, I would like to express my deep appreciation towards my interviewees
who are listed in the appendix.
IV
CONTENTS
INTRODUCTION......................................................................................................................... 1
CHAPTER 1 MARKET ENTRY AND THE THEORY OF THE FIRM .................................... 4
1.1 THE THEORIES OF THE FIRM .................................................................................................... 5 1.1.1 The firm in the conventional economic theory................................................................. 5 1.1.2 The transaction cost (TC) theory of the firm ................................................................... 5 1.1.3 The bounded rationality (BR) theory of the firm.............................................................. 8 1.1.4 The agency theory of the firm......................................................................................... 8 1.1.5 The strategic theories of the firm.................................................................................... 9 1.1.6 The firm in the eyes of organizational scientists............................................................ 10
1. 2 CONCLUSION....................................................................................................................... 11
CHAPTER 2 MARKET ENTRY MODE CHOICE: COGNITIONS FROM EMPIRICAL AND THEORETICAL STUDIES........................................................................................................ 14
2.1 INTRODUCTION .................................................................................................................... 14 2.1.1 A critical issue in international marketing .................................................................... 14 2.1.2 The existing models...................................................................................................... 15 2.1.3 The existing empirical studies ...................................................................................... 16
2.2 DISCUSSION ON THE ESTABLISHED QUALITATIVE THEORIES ................................................... 18 2.2.1 The SD model .............................................................................................................. 18 2.2.2 The TCA model and its extensions ................................................................................ 18 2.2.3 The OLI model............................................................................................................. 21 2.2.4 The OC model.............................................................................................................. 23 2.2.5 The DMP models ......................................................................................................... 23 2.2.6 In Summary ................................................................................................................. 24
2.3 SOME CONFLICTING RESULTS................................................................................................ 25 2.3.1 Conflicting results of theoretical studies....................................................................... 26 2.3.2 Conflicting results of the empirical studies ................................................................... 28 2.3.3 Summing up................................................................................................................. 29
2.4 IMPLICATIONS AND OUTLOOK ............................................................................................... 30 2.4.1 Implications for international marketing practice ......................................................... 31 2.4.2 Outlook for future research.......................................................................................... 32 2.4.3 The guidelines for this dissertation............................................................................... 37
CHAPTER 3 SMES’ MARKET ENTRY MODE CHOICE: RISK AVERSION AND ENVIRONMENT ........................................................................................................................ 39
3.1 QUANTITATIVE MODELS OF ENTRY MODE CHOICE .................................................................. 39 3.2 A NEW MODEL OF ENTRY MODE CHOICE ................................................................................ 41
3.2.1 The SMEs .................................................................................................................... 41 3.2.2 Notations and the model............................................................................................... 42 3.2.3 Solutions...................................................................................................................... 46
3.3 IMPLICATIONS AND PROPOSITIONS ........................................................................................ 50 3.3.1 Comparative static analyses......................................................................................... 50 3.3.2 Comparison with prior results...................................................................................... 58
3.4 DISCUSSION ......................................................................................................................... 59 3.5 CONCLUSION ....................................................................................................................... 61
CHAPTER 4 LARGE FIRMS’ MARKET ENTRY MODE CHOICE: MANAGERIAL DISCRETION AND EXPENSE PREFERENCE ....................................................................... 62
4.1 SEPARATION OF OWNERSHIP FROM MANAGEMENT ................................................................. 63 4.1.1 Two significant consequences....................................................................................... 63 4.1.2 Managerial discretion models ...................................................................................... 64
4.2 THE FRAMEWORK OF LARGE FIRMS’ ENTRY MODE CHOICE MODEL .......................................... 65 4.2.1 Managerial discretion of the revenue maximization...................................................... 65 4.2.2 Expense preference...................................................................................................... 67
V
4.2.3 Definition of entry modes ............................................................................................. 68 4.2.4 The structure of market and time.................................................................................. 68
4.3 THE STRATEGIC DECISION OF THE BOARD .............................................................................. 69 4.3.1 Notations and assumptions........................................................................................... 69 4.3.2 The profit of investing via JV........................................................................................ 70 4.3.3 The profit of investing via acquisition........................................................................... 71 4.3.4 The profit of investing via Greenfield WOFV................................................................ 71 4.3.5 The choice of entry mode strategy ................................................................................ 72
4.4 THE MANAGERS’ TACTIC DECISIONS...................................................................................... 74 4.4.1 Notations and assumptions........................................................................................... 74 4.4.2 The managers’ decision-making problem ..................................................................... 76 4.4.3 Distortions of investment.............................................................................................. 78 4.4.4 Summary ..................................................................................................................... 85
4.5 CONCLUSIONS...................................................................................................................... 87
CHAPTER 5 ORGANIZATION AND FOREIGN MARKET ENTRY MODE CHOICE........ 90
5.1 REVIEW OF THE LITERATURE ................................................................................................ 90 5.1.1 The OC theory ............................................................................................................. 91 5.1.2 Applications to entry mode choice ................................................................................ 92 5.1.3 The implications for entry mode study .......................................................................... 93
5.2 ORGANIZATIONAL ATTRIBUTES AND ENTRY MODE CHOICE..................................................... 94 5.2.1 Organizational performance, value system, and market entry ....................................... 94 5.2.2 Organizational philosophy ........................................................................................... 96 5.2.3 Organizational experience ........................................................................................... 98
5.3 CONCLUSION ..................................................................................................................... 102
CHAPTER 6 SYNTHESES OF THE SYSTEMATIC ANALYSES ON ENTRY MODE CHOICE.................................................................................................................................... 104
6.1 SUMMARY OF THE PROPOSITIONS ........................................................................................ 104 6.2 A CONCEPTUALLY SYSTEMATIC FRAMEWORK OF ENTRY MODE CHOICE ................................ 105
6.2.1 Exploring the determinants of entry mode choice........................................................ 105 6.2.2 Formulating the process of entry mode choice............................................................ 107 6.2.3 Why model entry mode choice separately ................................................................... 110
CHAPTER 7 MARKET ENTRY MODE CHOICE: GERMAN FIRMS IN CHINA ............. 111
7.1 WHY STUDY GERMAN FIRM’S INVESTMENT BEHAVIOR IN CHINA? ........................................ 111 7.1.1 China as an emerging market..................................................................................... 111 7.1.2 FDI in China ............................................................................................................. 112 7.1.3 German investment in China...................................................................................... 113
7.2 DATA AND METHODOLOGY ................................................................................................. 115 7.2.1 The sample ................................................................................................................ 115 7.2.2 The questionnaire and variables................................................................................. 115 7.2.3 The data .................................................................................................................... 119 7.2.4 The methodology........................................................................................................ 121
7.3 ANALYSES AND RESULTS.................................................................................................... 122 7.3.1 Factors influencing choice of China for FDI .............................................................. 122 7.3.2 Parametric tests of the hypotheses.............................................................................. 125 7.3.3 Non-parametric tests of the hypotheses....................................................................... 138 7.3.4 Penetrating the theses ................................................................................................ 139
7.4 CONCLUSION ..................................................................................................................... 145
CHAPTER 8 CONCLUSIONS AND OUTLOOK.................................................................... 147
REFERENCES.......................................................................................................................... 151
APPENDIX: LIST OF THE INTERVIEWEES ....................................................................... 167
QUESTIONNAIRE ................................................................................................................... 168
VI
List of variables and parameters
θ : investing firm’s ownership ratio in the joint project
( )q x : output
( )f fq x : output in the host country
( )h hq x : output in the home country
x : capital input fx : capital input for the joint production in the host country hx : capital input for the production in the home country
X : investing firm’s capital capacity fr : capital cost rate in the foreign country hr : capital cost rate in the home country
fF : fixed cost of investment in the foreign country hF : fixed cost of investment in the home country
p : output price
a : a constant in inverse demand function fp : output price in the foreign country hp : output price in the home country
ft : income tax rate in the foreign country ht : income tax rate in the home country
1c : marginal cost of production of the investing firm
2c : marginal cost of production of the foreign firm
fC : actual cost incurred by the investing firm in the foreign country hC : actual cost incurred by the investing firm in the home country
m : premium arisen from the investing firm’s acquisition activity
S : managerial expense fR : investing firm’s revenue due to its operation in the foreign country hR : investing firm’s revenue due to its operation in the home country
π : aggregate profit of the investing firm fπ : investing firm’s profit due to investment in the foreign country hπ : investing firm’s profit due to investment in the home country
β : portion of revenue employed by the managers for emolument
U : decision maker’s utility of decision making
VII
List of Figures
Figure 1.1 Systematic logic of firms' strategic decision-making
Figure 3.1 Possible solutions to the optimization problem
Figure 3.2 Elasticity of optimal ownership ratio with respect to capital cost rate
Figure 3.3 Elasticity of optimal ownership ratio with respect to income tax rate
Figure 4.1 Distortion f entry mode choice from profit maximization
Figure 4.2 Possible solutions to the optimization problem
Figure 5.1 "Humanity" and "Ethnocentrism" theory of the firm
Figure 6.1 Factors influencing entry mode choice
Figure 6.2 Procedures of entry mode choice
Figure 7.1 FDI inflow to China (1999 - 2004)
Figure 7.2 German investment in China (1995 - 2003)
Figure 7.3 Overall German investment distribution
Figure 7.4 Origin of German investment
Figure 7.5 Destination of German investment
Figure 7.6 Mean plots (risk aversion-entry mode)
Figure 7.7 Mean plots (firm size-entry mode)
Figure 7.8 Mean plots (market size-entry mode)
Figure 7.9 Mean plots (estimated risk-entry mode)
Figure 7.10 Mean plots (tax regime-entry mode)
VIII
List of Tables Table 1.1 Summary on the theories of the firm
Table 2.1 Factors examined in the existing empirical studies
Table 2.2 An assessment of the existing theories on entry mode choice
Table 2.3 Conflicting theoretical interpretations and empirical results
Table 4.1 Distortions of entry mode choice
Table 6.1 Propositions review
Table 7.1 Analysis on key FDI destination countries
Table 7.2 Sample profile
Table 7.3 Key characteristics of entry mode alternatives with coding
Table 7.4 3-equivalent-distance scale coding of independent variables
Table 7.5 Test of normality
Table 7.6 Test of homogeneity of variances
Table 7.7 Factors influencing German firms' choice of China for FDI
Table 7.8 Data description (risk aversion-entry mode)
Table 7.9 ANOVA (risk aversion-entry mode)
Table 7.10 Multiple comparisons (dependent variable: Entry mode)
Table 7.11 Data description (firm size-entry mode)
Table 7.12 ANOVA (firm size-entry mode)
Table 7.13 Data description (potential market size-entry mode)
Table 7.14 ANOVA (potential market size-entry mode)
Table 7.15 Data description (estimated risk-entry mode)
Table 7.16 ANOVA (estimated risk-entry mode)
Table 7.17 Multiple comparisons (dependent variable: entry mode)
Table 7.18 Data description (tax regime-entry mode)
Table 7.19 ANOVA (tax regime-entry mode)
Table 7.20 Kruskal-Wallis tests statistics (a,b,c)
Table 7.21 Arguments on the choice between JV and WOFV
Table 7.22 Firms' route map of development in China
1
Introduction
This dissertation aims to study the firms’ foreign market entry problem from a
theoretical as well as an empirical point of view.
This topic is actually not new in the literature of economics as well as business.
Economists and business scientists have exerted a great effort in modeling this
pivotal strategic decision-making problem, and numerous models, qualitative or
quantitative, have arisen since the early 1970s. A rich empirical literature, which
aims to test the theoretical models developed (i.e. mainly the qualitative ones) or to
identify the determinants of entry mode choice, has been extant since the early
1980s. However, as suggested by Decker and Zhao (2004a), there are no widely
accepted models. Each model has its strengths and weakness, and there have been
empirical studies whose results have not agreed with each other. Additionally, since
the end of 1990s, the creation of new models has been rare, however the empirical
studies are abundant. Therefore, there is a great need to put forth some effort to
remodel this problem under a new economic situation, with a particular focus on the
German firms’ investment behaviors in an emerging market, such as China.
An in-depth analysis of the existing theoretical models of foreign market entry, as
shown in chapter 2, indicates that the existing entry mode choice models uniformly
proceed using the existing theories of the firm, which are presented in chapter 1.
Therefore, a new model of market entry should originate from a new branch theory
of the firm or from a new understanding of the theory of the firm.
Foreign market entry is an ill-defined, complex, and dynamical decision-making
problem (Kumar and Subramaniam 1997, Young et al. 1989). Such a problem in the
eyes of organizational scientists is nothing but a strategic decision-making problem
(Pennings 1986, Evan 1993).
In contrast to economists, organizational scientists usually study a firm and its
strategic behaviors with a systematic approach (Robbins 1983 and 1993, Pennings
2
1986, Evan 1993). This systematic approach1 considers not only the internal
efficiency of an organization but also its fitness with the external environment, while
stressing the joint impact of each systematic component, namely the decision maker,
organization, and environment, on strategic behaviors.
Following this systematic logic, the dissertation is structured as follows.
Chapter 1 briefly reviews the main existing theories of the firm. This offers
insight into the foundation of the theories of market entry. Additionally, this shed
light on the new direction of modeling market entry mode choice.
Chapter 2 analyzes the existing models and approaches as well as the empirical
studies of market entry. Some implications are given for managers in practice and
for future research. This chapter originates from a previous paper by Decker and
Zhao (2004a).
Chapter 3 develops a quantitative model of market entry for Small and Medium
sized Enterprises (SMEs), which are characterized by an alignment of ownership
with management and by a perfectly competitive market for their inputs and outputs.
In this model, entry mode choices are determined by the internal efficiency of
resource allocation under the constraints of capital budget and host country policies.
This model offers rich implications for the decision makers of the firms concerned
as well as the policy makers in the host country. This chapter, among other things,
generalizes the previous papers by Decker and Zhao (2004 b,c).
Chapter 4, recognizing that the separation of ownership from management has
been widely acknowledged as a significant property of large firms, develops a two-
stage decision-making model, in which the board of directors, representing the
interests of the shareholders, make strategic decisions in respect to market entry and
the managers implement the strategy through tactical decisions. However, the
managers are assumed to enjoy great latitude of decision-making, which allows
them to favor private interests at the cost of the organizational interest of profit
maximization, i.e. managerial discretion (Williamson 1965, Jensen and Merkling
1976). Consequently, the decision makers take a positive attitude toward expenses,
1 This concept of “systematic approach” applies for the rest of this dissertation.
3
which bring them positive utility, i.e. expense preference (Williamson 1965).
Analysis of this model induces rich implications for the firms concerned as well.
Chapter 5 aims to study the influence of organizational characteristics on entry
mode choice systematically. There already exists an extensive volume of literature
having studied the impact of organizational characteristics on entry mode choice
separately and in different contexts. However, very few of them have studied entry
mode choice by taking the firm itself as the unit of analysis. The influence of value
system, organizational philosophy and organizational experience on entry mode
choice is discussed in this chapter respectively.
Chapter 6 summarizes the propositions and conceptualizes the systematic
framework of entry mode choice.
Chapter 7 empirically tests the systematic approach and identifies the potential
influences of each systematic component on entry mode choice respectively. Results
of this test are based on 20 in-depth interviews with German senior managers carried
out via a semi-structured questionnaire. The results support the systematic approach
significantly.
This dissertation identifies that entry mode theories are usually based on the
existing theories of the firm. Given this identification, this dissertation applies the
systematic logistic of the organizational theory of the firm as well as the economic
theory of the firm to model entry mode choice. This dissertation is consisted of both
theory development and empirical test. Entry mode choice in this dissertation is
modeled and tested both quantitatively and qualitatively.
The identified relationship between the theory of the firm and the theory of entry
mode choice and its successful application in this dissertation provide a good
perspective for entry mode theory development in the future. The systematic model
(qualitative and quantitative) in this dissertation makes up not only the scarcity of
theory development but also the shortage of quantitative models in the recent years’
literature, and it takes a new attitude toward firms’ strategic decisions, e.g. entry
mode choice. The interdisciplinary methodology, the qualitative and quantitative
techniques applied in this dissertation in the process of modeling and testing the
systematic model, will bring rich implications to future research as well.
4
Chapter 1 Market Entry and the Theory of the Firm
The study on the theory of the firm started with the early works done by Knight
(1921) and Coase (1937), however it did not blossom until the mid-seventies. The
theories of the firm have mainly discussed three issues, namely the existence, the
size and the organization of the business firm (Foss et al. 1998).
As recognized by Penrose (1959), the theories of the firm vary according to the
perspective from which the author wants the firm’s economic activities to be
considered, and can vary with the conceptual difference of various authors, resulting
from their backgrounds. Phelan and Lewin (2000) subdivided the existing theories
of the firm into two categories, namely the economic theories of the firm and the
strategic theories of the firm. The former category focuses more on the cost of using
a market mechanism, and the later stresses the benefit of using the firm in explaining
the existence and the size of firm (Conner 1991). Organizational scientists, on the
other hand, study firms from a quite different perspective.
Therefore, this chapter aims to present a brief synopsis of the existing theories of
the firm. This helps to understand how firms’ economic activities are studied, and
therefore the origin of the theory of market entry, which is a firm’s boundary issue.
We note additionally that new directions of modeling market entry should stand on a
good understanding of the evolution of the theories of the firm.
This chapter is structured as follows. The dominant economic and strategic
theories of the firm are explained in the first section. Additionally, the organizational
scientists’ view of the firm is also presented in this section. This chapter then
concludes with some implications for research, which are applicable to this
dissertation.
5
1.1 The theories of the firm
1.1.1 The firm in the conventional economic theory
In the conventional price theory, which was mainly developed by prominent
economists such as Marshall and Pigou, the firm is mainly characterized by a
production technology. To formulate the firm’s economic activities beautifully in
mathematics, all of the firm’s economic behaviors were reduced to two quantifiable
variables, namely quantity and price. Therefore, the firm is at most a theoretical link
explaining the changes of price and quantity in response to external dynamics
(Langlois 1994, p.3). The firm’s existence and its boundary decision based on this
price theory are just plainly illogical, since the firm’s boundaries in price theory are
only a matter of assumption (Langlois and Robertson 1995). The firm, in this theory,
is assumed to be completely rational (i.e. symmetric information, complete
contracting, perfect calculation ability), and its economic behavior is determined by
different production technologies (Foss et al. 1998).
Obviously, despite of its modeling advantage the price theory of the firm suffers
from simplifying firms’ economic behavior as a production technology; and through
this, the theory loses the rich sights of firms’ behaviors, which motivates the
development of a significant amount of economical theories to address the theory of
the firm from different perspectives.
1.1.2 The transaction cost (TC) theory of the firm
Contribution of Coase (1937)
Recognizing that the firm cannot write a complete contract without incurring any
costs, i.e. the costs of using market mechanism, Coase in his groundbreaking article
“The Nature of the Firm” (Coase 1937) raised the concept of transaction cost.
Applying this concept, the author, in this article, analyzed two critical issues of the
theory of the firm, namely the existence and the size of the firm. He explained that
the existence of the firm is due to:
6
“The operation of a market costs something and by forming an organization
and allowing some authority (an “entrepreneur”) to direct the resources,
certain marketing costs are saved” (Coase 1937, p.5).
That is to say, firms arise from market failure, which is the result of transaction
costs. Additionally, he claimed that the firm exists to decrease the uncertainty or to
enjoy different government policies on price mechanism and organization. His
explanation on the size of the firm is from a comparison of the marginal cost with
the marginal benefit of organizing a transaction; the firm will stop its expansion
until the point where these two margins are equal. Coase’s great contribution to the
theory of the firm, except for looking at the firm differently from the traditional
price theory of the firm, lies at bridging the two systems of resource allocation, i.e.
the price mechanism on the one hand, and the authority on the other.
Williamson’s development
Williamson (1975 and 1985), inheriting Coase’s transaction cost concept,
developed the TC theory, which, as the author himself advertised, is an
interdisciplinary study, i.e. a fusion of economics, law, and organization. In
transaction cost economics, firms are treated as a governance structure rather than a
production technology. In comparison with Coase (1937), Williamson (1975, 1985)
had proposed:
1. That the transaction is the analysis unit of a firm’s economic activities
(Williamson 1985, p.41). Alternatively, the way by which the TC theory
treats economic organization problems is through “transaction costs”, and it
poses the problem of economic organization as a problem of “contracting”
(Williamson 1985, p.20). In addition, “any economic problem that can be
posed directly or indirectly as a contracting problem is usefully investigated
in transaction cost economizing terms” (Williamson 1985, p.41),
2. That opportunism, asset specificity, and bounded rationality are three
assumptions of market failure and thereby transaction costs. He stressed this
idea later in describing the attributes of the contracting process (Williamson
1985, p.31).
7
3. A comparatively institutional assessment on discrete institutional alternatives
(of which the classical market contracting is located at one extreme; the
centralized and hierarchical organization is located at the other; and the
mixed mode of firm and market organization is located in between) instead
of applying only the marginal analysis to determine the size of the firm
(Williamson 1985 p.42).
4. That the TC analysis should be put into a larger context involving a tradeoff
between transaction costs, production costs, and the social context in which
the transactions are embedded (Williamson 1985, p.22),
Criticisms on the TC theory
Despite of its popularity in explaining the corporate governance issues, the TC
theory bore much criticism. Kay (1982) criticized the TC theory by questioning the
treatment of three assumptions. His argument reads as:
“In particular, opportunism is too limited as motivational basis for
adequate treatment of economic activity, while asset specificity is neither
necessary nor sufficient for problems of economic coordination to arise,
even in the presence of bounded rationality and opportunism.”
Madhok (1996, 1997 and 1998) compared the TC theory with his OC theory, and
criticized the TC theory for its inadequateness and shallowness as a theory of the
firm.
In his 1996’s paper, Madhok argued that the inadequateness and shallowness of
the TC theory come not only from the restrictive assumptions of opportunism which
leads to market failure and the notion of the firm as a bundle of transactions or
contracts but also from solving the organizational governance or boundary issue as a
cost minimizing problem (Madhok 1996, p.578).
In Decker and Zhao (2004a), some other weaknesses of this TC theory were
summarized.
8
1.1.3 The bounded rationality (BR) theory of the firm
Recognizing the disadvantage of assuming perfect rationality (i.e. costless use of
price mechanism, symmetric information, complete contracting, etc.), Simon and
March developed the BR theory of the firm (Simon 1957, March and Simon 1993).
In the BR theory and its adherent, i.e. the behavioral theory of the firm (Cyert and
March 1992), the firm is treated as an authority organization. In this scenario,
satisfying replaces maximizing as a criterion for decision-making. The bounded
rationality assumption of the decision makers and the organization replaces the
perfect one. This behavioral theory shifts the process of decision-making to the core
of economic analysis. In this theory, the optimality of the decision-making process
guarantees the optimality of the result (Cyert and March 1992). In addition, the
process of decision-making is influenced by many factors, e.g. organizational goal
and organizational expectation, which are various facets of the organization itself.
Even though the BR theory and the behavioral theory of the firm are more close to
reality, they do not dominate the theory of the firm. These theories are more
descriptive than normative. They suffer from the strong assumption that optimal
decision-making processes generate optimal results. Furthermore, they ignore the
influence of individuals and environment on strategic decision-making.
1.1.4 The agency theory of the firm
Disagreeing with the symmetric information assumption in the conventional price
theory of the firm, the agency theory of the firm, which was originated from Alchian
and Demsetz (1972) and Jensen and Meckling (1976), argues that the information
asymmetry between the principal and the agent induces the costs of monitoring,
bonding, and residual right loss, which are defined as agency costs. Additionally,
they thought that it is essentially misguided to make a hard line between the market
and the firm, and that the firm is actually a nexus of special contracts, such as a
contract between employer and employee or a contract between buyer and seller
among others.
The agency cost theory was widely applied latterly (Feentra 1998, Feentra and
Hanson 2004) to analyze firms’ boundary issues or investment problems.
9
However, the problem is that monitoring is not a distinguishing feature of a firm,
managers in large firms operate within a pervasive web of accountability
mechanisms that substitute for monitoring, e.g. the constraints from financial
market, goods market, legal systems, and policies among others. More importantly,
the agency costs are inevitable consequence of vesting discretion to the managers
rather than residual rights, agent costs can be significantly reduced if the managerial
discretion is eliminated.
1.1.5 The strategic theories of the firm
According to Phelan and Lewin (2000), the strategic theories of the firm tend to
agree on three broad principles: 1) the resource-based nature of the firm, 2) the
determination of firm boundaries, and 3) the bounded-rationality. Representatives of
the strategic theories of the firm are the resource-based theory of the firm, the option
theory of the firm, and the dynamic transaction costs theory. Since the last two
branches are not widely applied for market entry studies, they are not discussed
here.
Economists usually regard the seminal book “The theory of the growth of the
firm” by Penrose (1959) as the origin of the well-known resource-based (RB) theory
of the firm. In this theory, a firm is a collection of productive resources, physical
and/or human-oriented. The author adopts a dynamic viewpoint towards the growth
of the firm (Slater 1979 in Penrose 1980), and claims that the optimal growth of the
firm involves a balance between the exploitation of existing resources and the
development of new ones (Penrose 1980, Rugman and Verbeke 2002). The
description of the strategic theory of the firm in her words reads as:
“A firm is more than an administrative unit; it is also a collection of
productive resources the disposal of which between different users and over
time is determined by administrative decision. When we regard the function
of the private business firm from this point of view, the size of the firm is best
gauged by some measure of the productive resources it employs” (Penrose
1980, p.24).
10
There are many followers of this RB theory of the firm. Conner (1991), Conner
and Prahald (1996), and Kogut and Zander (1992, 1993 and 2003) adopted this
modus operandi and developed the knowledge-based (KB) theory of the firm. In
addition, plenty of economists (Peteraf 1993, and Foss 1997, for example) have
applied this theory for competitive advantage analysis. Additionally, based on the
RB and the KB theory, Madhok (1996 and 1997) developed his organizational
capability (OC) theory. In this OC theory, the firm is defined as a bundle of
resource-based capabilities arising from knowledge, experience, or routines. The
motivation of the firm shifts to the conceptual “organizational capability”. The
firm’s boundary issue is thus determined and evaluated by the exploitation and
exploration of organizational capabilities.
1.1.6 The firm in the eyes of organizational scientists
As analyzed above, the existing economic or strategic theories of the firm
understood firms’ economic behaviors, i.e. existence, size, and/or organization, from
either the benefit or the cost perspective, i.e. an efficiency consideration. However,
Organizational scientists have studied the firm, its nature and growth, from different
angles. Evan (1993) has summarized six schools of organization theory. One can
assume, however, that the theories of the organization are not limited to these six
schools.
In organization theory, the firm as a whole is usually viewed as a profit-oriented
organization, which is hierarchically organized with each subunit pursuing its own
individual interest, and these individual interests are regulated by incentives (Koza
and Thoenig 2003). The firms’ survival and growth are essentially explained from
two aspects, namely the internal efficiency and the external fit of the firm with its
environment. The firm’s strategic behavior actually involves at least three levels of
analyses: (1) the subsystem of an organization, (2) the organizational system in its
entirety (i.e. cultural components, e.g. values, goals, and philosophies, the structural
components, and the technological components), and (3) the super system, i.e. the
interactions or linkages of the focal organization with other organizations and its
surrounding environment (Evan 1993, p.156). Similarly, firms’ strategic behaviors
are assumed to be a result of a systematic consideration as well, i.e. the individuals,
11
the firm itself, and the surrounding environment (Pennings 1986, Robbins 1993,
p.44). Figure 1.1 explains this systematic logic in detail.
The existing organization theories of the firm differ in nature from the economic
theories of the firm and the strategic ones in terms of the perspective from which the
firms are studied. The organization theories do not show great passion for explaining
the existence of the firm; rather they focus on studying the organization of the firm,
e.g. the survival and growth of the firm, and/or other operational decisions, such as
structure, design, strategy, bureaucracy, culture, etc.
This organizational scientists’ view toward firm’s growth and other strategic
decisions offers a new insight for firms’ market entry studies (Koza and Thoenig
2003).
Figure 1.1 The systematic logic of firms’ strategic decision-making
1. 2 Conclusion
As analyzed above, most of the existing economic theory of the firm is motivated
by unrealistic assumptions of the price theory of the firm, i.e. perfect rationality.
In comparison with the strategic theories of the firm, the economic theories of the
firm analyze the existence of a firm more from the cost of using market mechanisms
Input organizaiton set
The focal organization
Output organizaiton set
Social structure and culture
Inter-organization system (see the right figure)
The organization
Organizational subunits: decision
maker
The inter-organization system
Note: adapted from Evan (1993, p.250)
12
than from the benefit of using hierarchy. Therefore, in economic theories of the firm,
the size of firm (i.e. the boundary issue) is more dependent on a marginal cost
analysis of using two mechanisms (i.e. price mechanism on the one hand and
hierarchy on the other) rather than on an analysis of resource or benefits exploitation
and exploration, which is applied usually in strategic theories of the firm. The
economic theories of the firm are endowed with mathematical elegance and
normality; however, these theories on the prediction of the boundary of a firm are
only one side of the story. The strategic theories of the firm are more capable of
explaining the value creation and the location of firm boundaries; however, they
lack a proper explanation of the existence of a firm (Phelan and Lewin 2000). Both
the conventional economic efficiency consideration and the strategic competitive
advantage consideration are relevant to firms’ strategic behaviors. Ignoring any of
these two aspects can lead to a wrong description.
Differently, organizational scientists take a systematic attitude toward the firm,
which is more complete and in better tune with today’s complex commercial
environment. This systematic approach considers the internal efficiency during the
process of decision-making; this is feasible in practice and elegant in theory.
Furthermore, it also stresses the fitness between the firm and its surrounding
environment, which creates the long run competitive advantages. In some sense, this
systematic approach includes both the economic theory of the firm and the strategic
theory of the firm; alternatively, it can apply not only a normative analysis but also a
descriptive analysis. Meanwhile, this systematic logic highlights the influence of
decision maker on strategic choices. Today’s complex organizational structure and
dynamic environment leave the decision maker no given routine to follow and
therefore large latitude for discretion on their strategic decisions. The organization
as well as its surrounding environment provides the decision maker not only
sufficient conditions but also constraints to implement their strategic choices
(Madhok 1996, 1997). They cannot be ignored during the process of decision-
making.
Table 1.1 shows how the different theories of the firm view the economic
behavior of the firm differently.
13
Table 1.1 Summary on the theories of the firm
Categories Theories of the firm
Representatives Basic assumptions The size of firm
Price theory Marshall and Pigou
Rationality (costless contracting, symmetric information, complete contracting), the firm is a production technology
Determined by assumption
Transaction Cost (TC) theory
Coase (1937), Williamson (1975, 1985)
Costly and incomplete contracting, the firm is a collection of contracts
Internal efficiency: the costs of using market mechanism
Bounded Rationality (BR) theory and behavioral theory
Simon (1957), Cyert and March (1992)
Bounded rationality, the firm is an authority organization
Internal efficiency: optimizing the behavior process
Economic theories
Agency cost theory
Alchian and Demsetz (1972), Jensen and Meckling (1976), Jensen (2000)
Asymmetric information, separation of ownership from management, the firm is a corporate governance
Internal efficiency: minimizing the agency costs
Resource Based (RB) theory
Penrose (1959, 1980)
The firm is a collection of resources
Internal efficiency: benefits of exploiting the existing resources and developing the new ones Strategic
theories
Organizational Capacity (OC) theory
Madhok (1996, 1997)
The firm is a collection of resource based capacities
Internal efficiency: benefits of exploiting and exploring organizational capacities
Organizational theories
Various schools of organizational theories2
Pennings (1986), Robbins (1991), Evan (1993)
The firm is not only a profit organization but also a social component with hierarchies
Internal efficiency: costs and benefits External fitness: social structure, culture, inter-organizational system
2 See Evan (1993) for details.
14
Chapter 2 Market Entry Mode Choice: Cognitions from
Empirical and Theoretical Studies
This chapter aims to analyze systematically the existing literature, theoretical and
empirical, on market entry studies. A strength and weakness analysis on the existing
theories, both qualitative and quantitative, indicates that each theory has a limited
explanatory power of analyzing entry mode choice, and that each theory roots itself
at least in one theory of the firm. Observing the discrepancies in both theories and
empirical studies dealing with the entry mode choice, we conclude a significant need
for further research in this important area of international marketing. More
importantly, we provide some implications for managers in practice and outline
some trends of entry mode theory as well as some strategies for future research.
The remainder is arranged as follows. Section 2.1 describes briefly the evolution
of market entry studies in the field of international marketing. In section 2.2, an
overview of the existing theories and models on market entry is presented together
with discussions about their strengths and weaknesses. Conflicting results of the
existing theories and empirical studies are discussed in section 2.3. The theoretical
and empirical considerations drawn from this review are then used as the basis of
practical implications for marketing management and some general suggestions for
future research are outlined in section 2.4. This chapter concludes with some
specific implications for the remainder of this dissertation.
2.1 Introduction
2.1.1 A critical issue in international marketing
The interest in foreign market entry mode choice (for brevity, the terminology
“entry mode choice” will be used in the following) evolves from the issue of firm
boundaries, which is one of the critical issues in the theory of the firm, i.e. the
15
existence, the boundary, and the internal organization of firm. As analyzed later,
each theory of entry mode choice can trace its theoretical root to the theory of the
firm. Additionally, it has been studied as a problem with distinctive feature, extent,
form and pattern of international production (Southard 1931, Hymer 1960, Caves
1971 and 1974, Dunning 1958 and 1977). Economists and marketing experts have
discussed it as a critical issue in international marketing.
Wind and Perlmutter (1977) argued that the choice of market entry mode has a
great impact on international operations and can be regarded as “a frontier issue” in
international marketing. Root (1994) claimed that the choice of market entry mode
is one of the most critical strategic decisions for Multi-National Enterprises (MNEs).
The choice of entry mode affects a firm’s future decisions and performance in
foreign markets. Operating in a foreign market entails a certain level of resource
commitment, which is difficult to transfer from one level to another, especially from
a high level to a low level. Kumar and Subramaniam (1997), Chung and Enderwick
(2001), and Nakos and Brouthers (2002) emphasized that the choice of market entry
mode is a critical strategic-decision for firms intending to conduct business overseas.
2.1.2 The existing models
Being such an important issue, entry mode choice has become the object of
numerous theories and models developed to understand and explain the associated
phenomena. The existing theories3 can be divided into two sub-groups: qualitative
theories and quantitative ones. Qualitative theories are primarily conceptual and
abundant in the existing literature, whereas quantitative approaches4 are mainly
game theoretical and rare. Theoretical studies can also be classified into content-
orientated and process-orientated approaches. The former aims at the identification
of the determinants of entry mode choice and their possible influences, the latter
aims at the description of how this decision is actually made by following some
appropriate procedures.
3 In the following, the word “theory” is used synonymously with “model” or “approach”. 4 The quantitative approaches will be discussed in details in chapter 3.
16
Among the existing qualitative theories there are five basic approaches (which
will be discussed later on in this chapter) which are particularly prominent and have
been tested widely. They are:
1. the Stage of Development (SD) model (Johanson and Wiedersheim-Paul
1975, Brooke 1986),
2. the Transaction Cost Analysis (TCA) model and extensions (Anderson and
Gatignon 1986, Hill et al. 1990, Erramilli and Rao 1993),
3. the Ownership, Location and Internalization (OLI) model (Dunning 1977,
1980, 1988, 1995, 1998, and 2000),
4. the Organization Capability (OC) model (Madhok 1996 and 1997), and
5. the Decision Making Process (DMP) model (Young et al. 1989, Root 1994,
Kumar and Subramaniam 1997).
The quantitative models are mainly game theoretical and rare in the existing
literature. Grossman and Hart (1986) and their followers, as well as Buckley and
Casson (1998) and their followers are some representatives. Chapter 3 will explain
these models in details.
To our knowledge, no prominent models have been developed in recent years.
2.1.3 The existing empirical studies
Various empirical studies have been carried out to test the validity of the existing
theories, to find out factors that might have an impact on the choice of entry mode,
and to measure the corresponding effects.
The empirical studies have explored a pool of factors influencing the choice of
entry mode. These factors, as showed in Table 2.1, can be classified into country
specific, industry specific, firm specific and decision maker specific ones. Of course,
there is no exclusive classification on the factors examined; a factor might be
studied as a country factor in a certain context, but it might be taken as an industry
factor in others. However, this ambiguity does not affect the implication of the main
aspects by which entry mode choice is assumed to be influenced.
17
Table 2.1 Factors examined in the existing empirical studies
Clusters Factors examined Representative works
Cultural distance Chen and Hu (2002), Cristina and Esteban (2002), Evans (2002), Gillespie (2002), Leung et al. (2003)
Institutional effects Meyer (2001), Said and McDonald (2002)
Country risk and environmental uncertainty
Cristina and Esteban (2002)
Foreign exchange rate and host country currency
Baek and Kwok (2002)
Immigration effects Chung and Enderwick (2001)
Country experience and length of diplomatic ties
Tse et al. (1997)
Country specific
Market size Chung and Enderwick (2001), Eicher and Kang (2002), Nakos and Brothers (2002)
Technology transfer Mattoo et al. (2001)
Industry specific Industry barriers and firm advantages
Siripaisalpipat and Hosbino (2000), Chen and Hennart (2002)
Network relationship Coviello and Munro (1997)
Firm size Evans (2002), Nakos and Brouthers (2002), Leung et al. (2003)
Organization specific
International experience Reuber and Fisher (1997 and 2003), Evans (2002), King and Tucci (2002)
CEO successor characteristics
Herrman and Datta (2002) Decision maker specific
Role of staffing Konopaske et al. (2002)
The above way of clustering indicates us at least two points: (1) entry mode
choice is a complicated decision-making problem, which is influenced by multiple
variables; (2) the factors influencing entry mode choice can be explored from a
18
systematic perspective, i.e. the decision maker, the organization, and the
environment.
The possible influence of a factor on entry mode choice can be positive, negative,
or irrelevant. By positive, it means that the higher the value of a factor, the higher
equity mode will be adopted, and vice versa. However, the existing literature has
concluded conflicting results in terms of how some factors will influence the choice
of entry mode, the coming section 2.3 will explain this in details.
2.2 Discussion on the established qualitative theories
2.2.1 The SD model
Johanson and Wiedersheim-Paul (1975) proposed the stage of development (SD)
model (i.e. known as the “U” model while they were studying the
internationalization strategies of SMEs. The model asserts that the
internationalization of SMEs is a long, slow, and incremental process in two
dimensions: the geographical or cultural expansion and the level of commitment.
Brooke (1986) applied this approach to explain market entry. However, this model is
not perfect: it provides a set of feasible entry modes but not the right ones (Young et
al. 1989). This is because it is not capable of explaining why a newly established
firm starts entry with a wholly owned venture but not export. We note that the SD
model does not dominate the existing literature.
2.2.2 The TCA model and its extensions
The Transaction Cost Analysis (TCA) originated from Anderson and Gatignon
(1986). TCA is based on the TC theory of the firm, which was initiated by Coase
(1937) and Williamson (1975 and 1985) as a tool to explain economic problems
where asset specificity, uncertainty, and opportunism play a key role. The TCA
framework argued that MNEs choose a specific mode of entry that maximizes the
long-term risk-adjusted efficiency through minimizing of the transaction costs.
Different entry modes are defined by the level of control, which is a result of
ownership. Wholly owned ventures, for example, are characterized by the highest
19
level of control; export and contracting are characterized by the lowest level of
control.
In this TCA framework, entry mode choice depends on four constructs that
determine the optimal degree of control: transaction specific asset, external
uncertainty, internal uncertainty, and free riding potential (Anderson and Gatignon
1986). In their paper, Anderson and Gatignon (1986) applied proprietary content,
poor understandability, customization, and product class immaturity for measuring
the asset specificity, and country risk for measuring the external uncertainty. The
firms’ cumulative experience, socio-cultural distance and small business community
are the measures of internal uncertainty. Finally, brand value measures the
possibility of free riding.
The propositions suggested that the higher the transaction specificity of asset, the
uncertainties, and the possibility of free riding, the more efficient a high equity entry
mode is.
Other researchers then significantly supplemented the framework. Anderson and
Weitz (1986) applied the TCA framework to analyze the vertical integration and the
marketing productivity problems. Hill et al. (1990) integrated both the
environmental and the strategic factors. Klein et al. (1990) incorporated production
costs into the TCA framework and divided the external uncertainty into different
categories. Erramilli and Rao (1993) modified this framework to suit for service
industries through assuming that firms prefer a high level of control unless proven
otherwise. Lu (2002) put forward the institutional theory as complementary to the
TCA theory. The author claimed that the TCA theory is static and unable to explain
the evolution of entry mode. Brouthers (2002) addressed the institutional, cultural
and the transaction cost related factors. He claimed that the institutional factors refer
to the conditions that undermine property rights. The institutional factors increase
the risks of exchange and the cultural factors tend to influence managerial costs and
uncertainty evaluation in the target market.
The TCA framework and its extensions have been widely applied and tested in
empirical studies. Existing empirical literature found that the transaction cost related
factors influence entry mode choice significantly. Meyer (2001), based on a sample
20
of German and British MNEs in CEE, concluded that the unstable incomplete
institutions increase the transaction costs, therefore influence the entry mode choice.
Brouthers (2002) suggested that the firms, which make their entry mode choices by
applying this TCA criterion, are performing better than those who do not. Nakos et
al. (2002) analyzed both the market entry decisions and the performance of Dutch
and Greek SMEs in CEE and suggested that the TCA framework for MNEs tend to
apply for SMEs as well. Chen and Hu (2002) supported the framework of TCA by
examining foreign-invested firms in China from 1979 to 1992. Leung et al. (2003)
examined the TCA related factors affecting entry mode decisions of foreign banks in
China.
Despite of offering many insights into the role of corporate governance in entry
mode decision, the TCA framework and its extensions raise some doubts. These
doubts originate from the challenges of its ancestor, the TC theory of the firm. If the
assumptions of asset specificity and opportunism even in presence of bounded
rationality, as Kay (1982) argued, are really over restrictive, the TCA framework
becomes explicitly too narrow. Alternatively, as Madhok (1996) insisted, the
efficiency can be attained by maximizing benefits rather than minimizing costs, the
shallowness and partiality of TCA framework become obvious.
Additionally, the TCA frameworks have a very limited predictive power in entry
mode choice due to the following reasons:
1) transaction costs themselves are ambiguous and difficult to measure, what
more important however is that the transaction cost itself has no absolute
connection with corporate governance,
2) the effect of transaction costs in today’s business has fallen dramatically due
to technology development and economic integration (Downes and Mui
1998, Krempel and Plümper 2002),
3) it has a very limited explanatory power with respect to the complex
multinomial choice of market entry mode (Gatignon and Anderson 1988,
Klein et al. 1990),
21
4) it neglects many important aspects in terms of firms’ boundary decisions: the
government regulations (i.e. they generally define the feasible set of entry
modes), the production costs (Anderson and Gatignon 1986), the larger
strategic and the competitive context within which the firms are operating
(Madhok 1998), and non-profit goal of decision-making5 (Milgrom and
Roberts 1992). Moreover, it excludes non-transaction benefits (Anderson
and Gatignon 1986).
Therefore, the TCA framework offers very limited managerial guidelines in
practice despite of its popular appearance in existing literature.
2.2.3 The OLI model
The OLI theory was introduced by Dunning (1977) at a presentation on a Nobel
Symposium in Stockholm on “The International Allocation of Economic Activity”
intending to identify and evaluate the factors influencing both the initial act and the
growth of foreign production. The OLI model is based on a combination of the
economic theory of the firm as well as the competitive advantage theory of the firm.
In the following decades, the author himself (Dunning 1980, 1988, 1995, 1998, and
2000) developed this model further.
In his first presentation, Dunning recognized that the attempts to identify
distinctive features of foreign direct investment in terms of ownership endowments
had already been made by Southard (1931). Hymer (1960) further explored this
ownership endowment idea; Caves (1971 and 1974) refined and extended it later.
Many hypotheses focusing on the particular kinds of ownership advantages of
MNEs were proposed: production differentiation (Caves 1971), entrepreneur and
managerial capability (McManus 1972), for example. Dunning also acknowledged
Vernon’s (1974) concept of location advantage in explaining foreign investment.
This concept of location advantage was integrated by Dunning (1977) to explain
international production. Furthermore, Buckley and Casson (1976) suggested
5 Some MNEs might enter into a new market for strategic networking for instance. Alternatively, if some
shareholders of the MNE considered are meanwhile upstream or downstream partners of the MNE, they might
influence the MNE to adopt an entry mode, which does not maximize the profit of the MNE but their own ones.
22
internalization to explain international investment and they argued that MNEs would
internalize their activities in a foreign country if the costs of internalization were
lower than that of exporting or other contractual agreements.
The OLI theory stated that entry mode decisions are determined by the
composition of three sets of advantages as perceived by enterprises:
1. ownership advantages (i.e. advantages that are specific to the nature and the
nationality of the owner),
2. internalization advantages (i.e. advantages arising from transferring
ownership advantages across national boundaries within the organization),
and
3. location advantages (i.e. advantages arising from the fact that different
locations feature different resources, institutions and regulations affecting the
revenue and the cost of production).
The more OLI advantages a firm possesses, the greater the propensity of adopting
an entry mode with a high control level such as a wholly owned venture. Later
Dunning (1995, 1998, and 2000) updated the model and argued that competitive
advantages, market failure, collaboration, and dynamic environments should also be
integrated into the model, when decisions on international production are made.
The OLI model was widely applied in the past to explain entry mode decisions
and its basic ideas were supported by several empirical studies. Agarwal and
Ramaswami (1992) supported this theory by empirically examining a sample of
American service firms. Brouthers et al. (1999), and Nakos and Brouthers (2002)
adopted this framework to explain MNEs’ entry mode decisions when facing a
transition economy such as CEE.
In spite of its eclecticism, its improved measurability, and its improved
explanatory power, the OLI model is a static one. It intends to cover all factors
affecting entry mode decisions, but in fact, it fails to do so due to the ignorance of
strategic factors, the characteristics of and the situational contingency surrounding
the decision maker, and even the competition.
23
2.2.4 The OC model
Aulakh and Kotabe (1997) have discussed organizational capability as an aspect
that influences entry mode choice. Madhok (1996, 1997, and 1998) systematically
studied the organizational capability and proposed this OC approach.
This approach is based on the RB theory of the firm and its offspring, i.e. the KB
theory of the firm (Penrose 1959, Conner 1991, Kogut and Zander 1993, and Conner
and Prahald 1996). The RB theory regards a firm as a bundle of capabilities and
knowledge where individual skills, organization and technology are inextricably
woven together (Nelson and Winter 1982). The model argues that entry mode
decision is capability related, and it is made under a framework governed by
considerations of the deployment and development of a firm’s capabilities rather
than the costs of transactions.
The organization capability as an aspect of benefit is taken into account for the
first time in entry mode choice. However, this approach has some limitations:
1. there is an over emphasis on the future value rather than the short run profit.
Certainly, firms make their strategic decisions with long-run growth or
capability deployment and development as a goal, but not the only one,
2. the OC theory suffers, when it is used to solve the firm’s boundary decisions,
from the bad measurability of the OC itself. Because of this bad
measurability and impreciseness, the OC theory is therefore less applicable
in practice for managers,
3. the OC theory ignores explicitly the roles of decision maker as well as the
environment in the process of entry mode decisions.
2.2.5 The DMP models
The DMP models were represented by Young et al. (1989), Root (1994), Kumar
and Subramaniam (1997), Pan and Tse (2000), as well as Eicher and Kang (2002).
These models are traceable to the BR theory and the behavioral theory of the firm
(Simon 1957, Cyert and March 1992, March and Simon 1993), in which the
decision-making process has a greater influence on achieving the firm’s goals.
24
These models argue that entry mode choice should be treated as a multi-stage
decision-making process. In the course of decision-making, various factors, such as
the objectives of market entry, the existing environment, as well as the associated
risks and costs, have to be taken into account. Focusing more on optimizing the
process of decision-making rather than on calculating the economic efficiency, these
models are more descriptive than normative. However, designing the process of
decision-making very easily falls into two false directions, either too specific or too
general. The decision-making procedures of choice cannot be designed completely
distinct in nature. Additionally, it ignores the role of the organization itself and that
of the decision maker during the process of decision-making.
2.2.6 In Summary
The existing qualitative theories have studied entry mode from various
perspectives, e.g. economic efficiency, competitive advantage, decision-making
process, economic evolution, etc. Entry mode choice has been studied as a solution
of improving the organizational performance, e.g. the TCA, the OLI theory, and the
OC theory for instance. However, a systematic consideration of the decision maker
and the decision-making context is usually ignored during the process of entry mode
choice.
In practice, none of the existing models is widely applied by management due to
various reasons. For example, the TCA has a bad measurability; the SD approach is
too formalistic and therefore it cannot explain why some firms start entry with a
whole owned venture.
Table 2.2 summarizes the main aspects discussed above.
25
Table 2.2 An assessment of the existing theories on entry mode choice
Basic models
References Theory of the firm
applied Main arguments Limitations
SD model
Johanson and Wiedersheim-Paul (1975), Brooke (1986)
The evolution theory of firm (Nelson and Winter 1982)
Internationalization is a long, slow and incremental process of cultural and geographical expansion and commitment.
Can not explain why some newly established firms start with a high equity entry mode, such as FDI
TCA model and extensions
Anderson and Gatignon (1986),
Hill et al. (1990), Klein et al. (1990), Erramilli and Rao (1993)
Transaction cost theory (Coase 1937, and Williamson 1975 and 1985)
Efficiency- maximizing firms adopt entry modes which minimize transaction costs.
Bad measurability, little connection with corporate governance, over-restrictive assumptions
OLI model
Dunning (1977, 1980, 1988, 1995, 1998, and 2000), ect.
Economic theory as well as strategic theories of the firm
The more ownership, location and internalization advantages a firm possesses, the more likely it adopts a high equity entry mode.
A static model ignores the impact of the firm objective, the decision maker, and the situational contingency surrounding the decision maker.
OC model Aulakh and Kotabe (1997), Madhok (1998)
The RB (Penrose 1959), KB (Conner 1991, and Kogut and Zander 1993) among others
Entry mode decision depends on the deployment and development of firm capability, i.e. maximization of benefits.
It ignores other goals of market entry as well as the decision maker and the social and political environment.
DMP model
Young et al. (1989), Root (1994), and Kumar and Subramaniam (1997)
The BR and the behavioral theory of firm (Simon 1957, and Cyert and March 1992), etc.
Entry mode choice is regarded as a multistage process taking into account some important factors.
It ignores the impact of the organizational performance and the decision maker.
2.3 Some conflicting results
As could be seen from the discussion above, most of the existing studies aimed to
explore the factors, which are related to entry mode choice and their impacts. In fact,
there are many factors having to be taken into account in research and practice. Root
(1994) altogether identified 22 factors. In terms of the possible influence of a
specific factor on entry mode choice, the existing literature shows great
inconsistencies.
26
2.3.1 Conflicting results of theoretical studies
2.3.1.1 International experience
Theoretically, different schools of researchers insisted on the applicability of their
own approaches for explaining entry mode choice. By applying different
approaches, they explained the impact of a certain factor on entry mode choice quite
differently, e.g., international experience, and cultural distance.
In respect to international experience, some researchers have argued that a firm’s
level of international involvement is positively related to international experience,
i.e. the more international experience a firm possesses; the more efficient it is to
adopt an entry mode with a high level of equity involvement. There are different
versions of explanations. Stopford and Wells (1972) clarified this phenomenon by
the “humanity” of firm, i.e. a firm behaves humanlike and matures as it acquires
more experience from international markets. Similarly, Davidson (1980 and 1982)
illustrated this phenomenon with uncertainty, the more experience accumulated, the
less uncertainty, and therefore the more confident the firm is. Consequently, a high
equity entry mode is adopted. Anderson and Gatignon (1986) and Nakos et al.
(2002) supported this idea explicitly.
The counter-argument is that international experience is negatively related to
international involvement. This understanding bases itself on the “ethnocentric
orientation” of many international neophytes. Ethnocentrism leads inexperienced
firms to demand a high ownership first in order to exploit its advantages by holding
key positions. Later on, when the firm has acquired enough local knowledge and
when it has adapted to local conditions, a shared ownership or a low degree of
ownership is preferred. Wiechmann and Pringle (1979) supported this theory
explicitly. Stopford and Wells (1972) and Shetty (1979) found empirically that the
experienced firms prefer a joint venture (JV) rather than a wholly owned foreign
venture (WOFV).
Erramilli (1991) explained this dissent with an underlying time frame. He thought
that in the long-run entry mode choice is positively related to experience, however
entry mode choice is negatively related to experience in the short run. He therefore
27
compromised the two extreme explanations by structuring a “U” shaped relationship
between entry mode and experience:
“In our opinion, the key reason for the controversy appears to be the widely
differing time frames adopted by researchers in opposing camps. Proponents
of the positive relationship between experience and control, such as
Gatignon and Anderson (1988), have generally employed continuous, long-
term measures of experience. On the other hand, analysts who noted
negative relationships have typically focused their attention on the early part
of firms’ international evolution.”
This compromise is a step forwards in explaining the influence of organizational
experience on entry mode choice. However, applying the time frame as the only
argument for this “U” shaped relationship is very shallow, as it does not indicate the
essential motivation of the dynamics of entry mode choice.
2.3.1.2 Cultural distance
Cultural distance is another arguable factor. Some economists or marketing
experts pointed out that the cultural distance between the home and the host country
discourages the ownership involvement, i.e. it is negatively related to the level of
control. Some other economists argued that cultural distance encourages ownership
involvement.
Gatignon and Anderson (1988), Kogut and Singh (1988) and Erramilli and Rao
(1993) supported a negative relationship between the cultural distance and entry
mode choice. This can be explained
1. by managers shying away from ownership involvement when they have no
or merely inconsistent knowledge about local values or operation methods
(Davidson 1980 and 1982, Root 1994), or
2. by managers undervaluing the investment due to uncertainty caused by
cultural distance (Root 1994), or
3. by high information collection costs due to cultural distance (Root 1994), or
4. by high managerial costs, e.g. due to training requirement.
28
A positive relationship is explained by the fact that ownership makes it possible to
make things done in its own way, which is assumed to be more efficient and more
advantageous (Hymer 1960). Padmanabhan and Cho (1996) as well as Anand and
Delios (1997) supported this theory with empirical studies.
Again, these two phenomena coexist in reality, both explanations are reasonable.
However, their predictability and the ability to generalize are very restrictive. The
predictive direction of this relationship is dependent on a specific context.
2.3.2 Conflicting results of the empirical studies
Some empirical studies are divergent with respect to what kind of influence
individual factors might exert on entry mode choice.
International experience, which is assumed to have important implications for
entry mode decision, has been examined empirically with a high frequency.
Surprisingly many conflicting results can be observed. Findings, which support a
positive relationship, were reported by Caves and Mehra (1986), Anderson and
Gatignon (1986), Erramilli (1991), Argarwal (1994), Reuber and Fisher (1997),
Evans (2002), Herrman and Datta (2002) and King and Tucci (2002). In contrast,
Chung and Enderwick (2001) found some empirical support for a negative relation.
However, some other empirical studies have also concluded a non-significant
relation, e.g. Brouthers (2002).
There are also conflicting results with regard to the influence of cultural distance
on entry mode decision. Some studies (e.g. Hennart and Larimo 1998, Gatignon and
Anderson 1988, Treadgold 1988, Kogut and Singh 1988, Erramilli and Rao 1993,
Evans 2002, Cristina and Esteban 2002, and Leung et al. 2003) found that there is a
negative relationship between cultural distance and entry mode choice. Other
empirical studies provided evidence for a positive relationship. This, for example,
applies for Padmanabhan and Cho (1996) and Anand and Delios (1997).
The size of a firm is also an important factor, which has initiated many
examinations in the past. It leads however also to obviously conflicting results.
Caves and Mehra (1986), Kogut and Singh (1988), Erramilli and Rao (1993) and
Leung et al. (2003) supported the assumption that the bigger a firm is, the more
29
efficient it is to adopt a high equity entry mode. Conversely, Reuber and Fisher
(1997) as well as Evans (2002) found that the size of a firm is not an important
contributing factor.
The regularity of conflicting influences of some specific factors on entry mode
choice implies that a deterministic relationship between a factor and entry mode
choice can easily be concluded, but is difficult to generalize.
2.3.3 Summing up
The theories as well as empirical investigations analyzing the possible influence
of a specific factor on entry mode choice derive controversial results. These
contrasts are depicted in Table 2.3.
The existing inconsistencies can be explained from many different perspectives.
Essentially, entry mode choice is a strategic behavior, which is ill defined and
complex (Young et al. 1989, Kumar and Subramaniam 1997), therefore it is the
result of a great set of determinants, psychological, economical, and political, and
their interactions. Trying to examine a specific factor’s influence while keeping
other factors constant is feasible and fruitful in theory, but this is not manageable in
practice. Moreover, the contrary observations might arise for the following reasons:
1. different researchers might start their research with different expectations
under different theoretical guidance,
2. different studies apply different methodologies with different samples,
3. a specific factor may exert contrary effects simultaneously on entry mode
choice, the consequence depends on which strength is dominant in a
specific context.
30
Table 2.3 Conflicting theoretical interpretations and empirical results
Factor Positive relation Negative relation Irrelevant relation
Inter-national experience
Anderson and Gatignon (1986), Davidson (1980, 1982)
Wiechmann and Pringle (1979)
Theoretical interpretations
Cultural distance
Hymer (1960)
Erramilli and Rao (1993), Gatignon and Anderson (1988), Kogut and Singh (1988)
Inter-national experience
Evans (2002), Herrman and Datta (2002), King and Tucci (2002), Reuber and Fisher (1997), Agarwal (1994)
Chung and Enderwick (2001)
Brouthers (2002)
Cultural distance
Anand and Delios (1997), Padmanabhan and Cho (1996)
Leung et al. (2003), Cristina and Esteban (2002), Evans (2002), Treadgold (1988), Gatignon and Anderson (1988), Erramilli and Rao (1993), Kogut and Singh (1988)
Empirical results
Firm size
Leung et al. (2003), Erramilli and Rao (1993), Kogut and Singh (1988), Caves and Mehra (1986)
Evans (2002), Reuber and Fisher (1997)
Source: Decker and Zhao (2004b), “SMEs’ Choice of Foreign Market Entry Mode: A Normative Approach”, International Journal of Business and Economics 3 (3), p.185.
2.4 Implications and outlook
From the above analyses and considerations, we can extract some useful
implications for marketing management practice. Meanwhile, the existing conflicts
between theory and empirical “reality” allow us to derive some implications for
future research and this dissertation in particular.
31
2.4.1 Implications for international marketing practice
2.4.1.1 Serious decision on mode of entry
As economists have highlighted, entry mode choice is a “critical strategic
decision”, or a “frontier issue” of international marketing. Entering into a new
market especially via high-equity modes usually involves a concomitant
commitment of resources, which cannot be easily transferred from one form to
another. A high resource-commitment entry mode usually exposes the firm to great
risk (Anderson and Gatignon 1986).
As analyzed above, due to the complexity of entry mode choice, there is no
widely accepted model. In addition, the theories as well the empirical studies
contradict themselves on what factors are influential and how. Therefore, managers
cannot find a direct answer from the existing literature to how entry mode decisions
should be made in their cases.
The managers should thus seriously consider their entry mode decisions especially
when it is a choice of a high equity mode. Certainly, this is not to suggest that one
should always start with a low equity mode to avoid risk, doing so might definitely
miss a good chance. The main point is to find a way maximizing the success rate.
2.4.1.2 How to maximize the success rate
To maximize the possibility of success is the goal of a rational decision maker,
this problem occurs frequently however yields no simple solution. With respect to
entry mode choice, there are no rules to guarantee complete success, however some
implications can be inferred from the above analyses. The first step is to make an
extensive evaluation on the potentially influential variables; secondly, to optimize
the decision-making process.
As indicated above, there are a multiple of factors that should be considered
during the process of entry mode choice. These factors can be explored from the
perspectives of the host and home countries, the industrial characteristics, the firm’s
characteristics, the decision maker’s characteristics and the product characteristics.
This is not to say that no variables are insignificant. In fact, there are some factors,
which do not play such an important role, and hence can be ignored. Among the
32
identified variables, a high weight should be given to those highlighted in the
existing literature, e.g. experience, cultural distance, country risks, and the decision
maker’s characteristics, etc. Of course, there are always some hidden factors, which
are important in essence however are often ignored, organizational philosophy is for
example. This asks for a systematic process of assigning this responsibility to
different departments or individuals, accompanied with some evaluations.
Meanwhile, the decision-making process is an important consideration. Those
DMP models formulated by Young et al. (1989), Root (1994), and Kumar and
Subramaniam (1997) offer useful implications for entry mode choice in practice.
Especially, the hierarchical decision-making model by Kumar and Subramaniam
(1997) is applicable to the SMEs, which are short of resources.
Additionally, the great inconsistencies in the existing theories and empirical
studies in terms of the possible influence of some factors on entry mode choice
indicate the managers a careful comparison on the decision-making context in the
existing literature with that they have in reality. A better correlation between the two
contexts implies a better applicability of the relevant results from the existing
literature.
Finally, an objective evaluation of the benefits, the costs and the risks of each
alternative entry mode during the process of decision-making is critical.
2.4.2 Outlook for future research
2.4.2.1 Some trends in entry mode theory
1) A dynamic and/or longitudinal decision-making model
We could notice that entry mode choice was primarily regarded as a one-stage or a
static decision-making problem in prior literature. In reality, it is often a multiple-
stage problem, which involves at least a process of goal formulation, alternative
strategies identification, and optimal or suboptimal strategy selection. It is ambitious
to suggest a dynamic choice model as representing the process as it involves a
hierarchy of single decisions, each of which being an attempt to improve the
outcome in the light of new information gained in previous decisions. However, it
33
can provide a more realistic description of human problem solving than a static one
does. Furthermore, firms having started to enter into a foreign market may change
their original strategy due to learning effects or unscheduled developments.
Therefore, a dynamic model considering the longitudinal aspects, as which is
developed later in this dissertation, is desirable to gain a better understanding of
entry mode decisions. Some other researchers, Pan and Tse (2000) for instance, have
realized this trend and have attempted to formalize and explain the phenomenon,
however it still deserves attention in future research.
2) Comparative studies
The entry mode decisions have been studied primarily as a profit maximization
problem of industrial or non-industrial organizations, which exist solely for profit
and growth. No matter the efficiency considerations of the TCA framework by
minimizing the “friction” costs, or the competence and/or growth consideration of
the OC theory by maximizing benefits, they are both profit oriented. However, there
are some non-industrial organizations, e.g. public universities, whose existence is
not mainly driven by profit, expansion or growth. Thus, their market entry decisions
are not made on the basis of profit maximization. Entry mode decisions of profit-
oriented organizations therefore can be different with those of non-profit oriented
organizations. These differences still need to be investigated in depth. Furthermore,
the choice of entry mode might differ in different time periods due to different
macro or microeconomic contexts. Therefore, inter-temporal studies of this problem
might can possibly induce a better understanding of entry mode theory. As far as the
literature concerned, there are few existing papers having studied this problem from
these two aspects.
3) A multi-objective problem
As the existing qualitative and quantitative models indicated, the profit or
efficiency maximization dominates other goals or considerations during the process
of entry mode choice. However, industrial organizations’ entry into a new market
might be not only for the goal of profit maximization but also for other purposes,
e.g. network building, information gathering, etc. These goals may be of conflicting
natures and can hold different priorities on entry mode decision. Therefore, if we
34
redefine the problem by taking into account other objectives of foreign market entry,
we may have to solve it in a quite new style. There should be at least a tradeoff
process among these different goals. Recently Hajidimitriou et al. (2003)
constructed a goal-programming model to solve entry mode choice as a multi-
objective problem. It is possible that future research will be able to solve this multi-
objective problem with different economic methods.
4) A systematic model of entry mode choice
As analyze above, most of the existing literature focuses on the identification of
the factors, which influence the market entry decision, and on their possible impact
on this decision. These studies result mostly in a partial behavior analysis (Dunning
1988, 2000). Being specific to a certain context and time period, the implications
from a partial behavior analysis are limited and difficult to generalize. This
limitation is confirmed by the great inconsistencies in the existing literature.
Restricting to some selected factors may easily lead to wrong or inconsistent
conclusions, just like one who touches only a leg of the elephant and claims that an
elephant looks like a tree. So, more general business strategy models are needed to
analyze the entry mode choice and to explain the genesis of the corresponding
decision.
As identified in chapter 1, entry mode models usually find their roots in at least
one branch of the firm theories. The development of such a general business strategy
model should also refer to the existing theories of the firm, which might offer new
insights into the behavior of a firm. Organizational scientists usually adopt a
different approach when firms’ economic behaviors are being studied, i.e. a
systematic approach (Pennings 1986, Evan 1993). This systematic theory of the firm
is more complete and better in tune with today’s complex economic environment.
Therefore, introducing this systematic concept to study the entry mode choice
could generate new insights. Moreover, such a general or systematic model should
be engaged on an individual, organizational as well as institutional or societal level
of analysis in terms of the internal and external efficiency. Why is so? Since entry
mode choice is usually made directly by the owners and/or managers, individually
or cooperatively. The individuals’ behavior is a reflection of their preferences, which
35
are influenced by the bounded rationality (i.e. inadequate information, limited
computational skills and uncertainty, etc.), the defined roles in the organization, as
well as being contingent on the environment around them. As argued by Evan
(1993), organizational strategy, organizational structure and environment factors are
in a close relationship; a good matching between the environment and the
organizational strategy and structure is positively related to performance.
Organizational behavior and individual decisions can shape as well as mirror the
environment, and the environment can affect individual as well as organizational
behavior.
2.4.2.2 Some research strategies for entry mode theory
Referring to the previous analysis, we suggest in the following some research
methodologies or areas of interest, which could be explored further in future
research.
1) Case study methodology
Almost with no exception, previous empirical studies on entry mode choice were
implemented with sample surveys. One problem of the sample survey is that the
analytical results are quite dependent on the sample quality. The quality of the
sample is however subject to a large number of factors, e.g. the design of the
questionnaire, the rate of reply, the validity of the answers among others. The
sample quality is thus very difficult to control. The other problem of the sample
survey is that the analytical results are very easily to be generalized by mistakes.
Actually, the analytical results even from a large sample are usually valid only
within the specific context, which is represented by the sample. Thus, the effort of
generalizing the analytical results of a sample survey usually ends in vain. However,
if we narrow our focus to specific firm or firms, the analysis could offer more in
depth insight; thereby present some practical implications for managers. Of course, a
case study cannot escape the weakness of generalization yet.
2) Computer simulation methodology
36
Economists have indicated the great importance of the right entry mode to firms’
final success. A wrong decision, especially a choice of a high equity entry mode,
could incur a big loss in time, money and/or other resources.
Therefore, a simulation on the performance of an entry mode in a similar context
before the final decision may offer the decision makers good insights in advance.
However, the use of computer simulations in the study of entry mode choice is
almost as neglected as the case methodology. Computer simulations on the
performance of entry mode decision in a similar context could help to reduce the
risk of a wrong entry mode choice. To answer this question, several studies have
suggested potentially fruitful applications of this methodology to strategic decision-
makings (Nagy et al. 1989, Nersesian 1990). Applying this methodology to study
entry mode choices is feasible. A computer simulation before the final choice of
entry mode may be more scientific and correctly corresponds to reality.
3) Interdisciplinary methodology
In the past, the problem at hand has been studied from different aspects of
economic theories, e.g. the TC theory (Coase 1937, and Williamson 1975 and 1985),
the network economics (Coviello and Munro 1997), the institution economics
(Meyer 2001, Brouthers 2002, and Lu 2002), and information and uncertainty
(Müller 2001). However, as far as we know, very few of the existing papers have
studied this problem from an interdisciplinary perspective including the knowledge
from organization theory and behavior science (Herrmann and Datta 2002 inspected
the impact of successor CEO characteristics on entry mode choice for instance). The
existing backlog in this respect should be accounted for in future research. Being a
decision-making problem, entry mode choice might share some similarities with
other decision-making problems. For example, in the Art of War6, Sun Tzu
articulated the preconditions of successfully initiating a war. He analyzed, in detail,
6 One of the most outstanding works is “The Sun Tzu Art of War” which is regarded as the bible of military
science in China and one of the oldest military treaties in the world. It was widely translated into several
languages (Giles 1910, Griffth 1988) and applied to various aspects of business, e.g. marketing, human
resource and career building (see for example http://www.clearbridge.com/current.htm). However, according
to our knowledge, it has not been applied to market entry mode studies so far.
37
the decision makers, the organization, and the institutional environment. So referring
to such a prominent decision-making method in future research, which is consistent
with the systematic concept of strategic decision-making formulated by
organizational scientists, could offer a new methodology of entry mode study. In
addition, entry mode decisions can be studied axiomatically by other economic
disciplines such as option theory (Li 2003), which is one strategic theory of the firm
(Phelan and Lewin 2000).
4) Sights on emerging markets
Some researchers have investigated the entry mode choice in an emerging market,
such as Leung et al.(2003), Nakos and Brouthers (2002). However, this is not to say
that there is no need for further study in this field. On the other hand, the wide
inconsistencies existing in the literature inspires further research with different
samples or methodologies. A large or significantly growing market capability, a
transitory economic and political system, a dynamic consumption behavior, a
distinct culture and a favorable investment environment characterize the newly
emerging markets (e.g. China). These markets offer a good chance of development
especially for SMEs. However, due to the big physical distance and distinct culture,
there are still many existing challenges for investment. Therefore, further research is
still expected to answer such kind of questions as to how German firms should make
their entry mode choice for entering into China.
2.4.3 The guidelines for this dissertation
We have derived from the existing literature some trends and research strategies
for the study of entry mode choice; however, the question is which trend and
strategies will be applied for this dissertation.
Among the four trends of entry mode theory, which are proposed in section
2.4.2.1, this dissertation will focus on the systematic approach with a longitudinal
consideration. In correspondence to the indication derived in chapter 1 that the
theory of entry mode usually originated from the theory of the firm, the systematic
approach can explicitly find its roots in the organizational theory of the firm.
However, this is not to say that the other trends are not important or do not deserve
38
further research. Additionally, another important implication from the existing
empirical literature is that firms in different size brackets operate in different
fashions, and thereby choose their entry modes with different strategies. This is quite
reasonable: small firms differ from large firms in many ways, such as organizational
structure, available resources and potential constraints, complexity and flexibility,
among others. However, this does not imply that a positive or negative relationship
exists between the firm size and entry mode choice.
Therefore, entry mode choice will be studied, in this dissertation, through a
systematic approach with a longitudinal consideration. Naturally, the consideration
of three systematic aspects, i.e. the decision maker, the organization, and the
environment, in the process of entry mode choice should happen simultaneously. For
simplicity, they are studied sequentially.
In respect to the research strategies, this dissertation is going to be an
interdisciplinary study on entry mode choice (i.e. applying the traditional economic
efficiency theory, the strategic theory of the firm, the psychological theory, the
organization theory, etc.). To test the developed model, this dissertation employs an
empirical test instead of a computer simulation. This is because the structure of the
systematic model, which will be visualized in chapter 6, is too complicated to allow
a simple simulation; an empirical test on the other hand is able to better examine the
validity of the model. To offset the limitation of the sample survey, the empirical
examination of the model developed in this dissertation is based on some in depth
interviews, which are guided by a semi-structured questionnaire. Finally, China, one
of the most prosperous emerging markets, is studied as a target market for German
firms’ market entry decision.
39
Chapter 3 SMEs’ Market Entry Mode Choice: Risk Aversion and Environment
As suggested in chapter 2, the entry mode choice, in this dissertation, will be
studied by taking three aspects, i.e. the systematic logic, the firm size, and dynamics
as well as longitude, into account simultaneously. This chapter thus starts with
modeling the entry mode choice of the SMEs. One of the significant properties of
the SMEs is the simple organizational structure, in which the owners are the
decision makers; therefore, there is an alignment of the decision maker’s interest
with that of the firm. This simple structure allows to investigate how the SMEs
interact with their surrounding environment in the process of strategic decisions, e.g.
entry mode choice.
Through analyzing the simple quantitative model developed, some qualitative and
quantitative propositions are induced for the decision makers, both in the companies
concerned and in economic policy. In addition, this theoretical model and its results
will be compared with those of prior relevant works.
This chapter is organized as follows. Section 3.1 describes the existing
quantitative models in brief. In section 3.2, a new quantitative model of entry mode
choice focusing on SMEs is developed. Practical implications and propositions for
the decision makers in the companies concerned and in economic policy, as well as
some comparisons with prior research, will be presented in section 3.3. Some
possible extensions on the model as well as its deduced implications are discussed in
section 3.4. The chapter closes with some conclusions.
3.1 Quantitative models of entry mode choice
The existing literature on entry mode choice primarily refers to MNEs. The
activities of SMEs have received far less attention (Kumar and Subramaniam 1997,
Nakos and Brouthers 2002). Meanwhile, the importance of SMEs’
40
internationalization has increased, however, tremendously in recent years (Nakos
and Brouthers 2002).
As demonstrated in the previous chapter, most of the existing theories are
qualitative and content-orientated and there is little congruence regarding the
applicability of the available models to the entry mode decision. Hardly any of the
existing models are explicitly tailored to the SMEs to our knowledge. Among the
very few quantitative models in the existing literature, the game theoretical ones are
dominant.
One branch is represented by Grossman and Hart (1986) and their followers, who
motivated their models by the transaction cost theory of Coase (1937) among others.
Buckley and Casson (1998) and followers represent the other branch, which bases
its models mainly on the internalization theory.
Grossman and Hart (1986) developed a two-period, two-player model to explain
vertical and lateral integration as a problem of ownership allocation efficiency based
on the assumptions that asset specificity and ownership are the purchase of non-
contractible rights. Optimal ownership is determined by equating the marginal
benefits of one party’s increased control with the marginal costs of the other party’s
loss of control. Later, many papers, such as Hart and Moore (1990), Feenstra (1998),
and Feenstra and Hanson (2004), suggested fruitful models by referring to the ideas
of the previously mentioned authors.
Buckley and Casson (1998) formulated a theoretical model investigating the
choice between export, licensing, joint venture (JV) and wholly owned foreign
venture (WOFV) in a two-firm economy. The optimal entry mode is selected by
eliminating the dominated strategies, i.e. those higher in cost and lower in profit.
Görg (1998), inspired by Buckley and Casson (1998), constructed a Cournot model
to investigate the influence of market structure on entry mode choice in a three-firm
economy. Müller (2001) constructed a two-period model for a two-firm economy. In
the first period, the MNE decides to enter either by acquisition or by Greenfield
investment or not to enter at all. In the second period, the MNE competes in price
with the local firm in the host country if entering by Greenfield investment or it
operates as a monopolist in the host country if entering via acquisition. Eicher and
41
Kang (2002) expanded on Müller (2001) to allow for international trade and
transport costs.
The above game theoretical models represent entry mode choice as an
optimization problem and enlighten the players’ strategic interactions during the
decision-making process. However, the SMEs are not actually in such an abstract
economy, they can neither compete as a duopolist when entering via Greenfield
investment nor operate as a monopolist when entering by acquisition. Additionally,
in such an economy, the environment in which the firms are embedded, is easily
ignored. The decision maker’s influence on entry mode choice is usually ignored in
the above models. On the other hand, the SMEs do not really make their entry mode
choice decision by following such a complicated thinking process. Most of the
existing quantitative models focus on the choice between acquisition and Greenfield
investment, i.e. between two alternatives of direct investment (wholly owned
venture) (Görg 1998, Müller 2001). Very few of them have integrated two
hierarchical decisions, namely the decision of investment and the choice of the mode
of entry into one framework.
Summing up, we can conclude that an explanatory framework fit for SMEs is still
indispensable. The new model we are going to develop in the next section provides a
concrete orientation for the SME’s entry mode decision, especially in a practical
respect. The model takes the decision maker and the environment in particular, in
which the former is embedded, into account. In this sense, this model is one part of
our systematic framework with a particular emphasis on the SMEs and their
surrounding environment.
3.2 A new model of entry mode choice
3.2.1 The SMEs
SMEs differ from MNEs not only in structural aspects but also with regard to the
entry mode choice (Erramilli and D’Souza 1993). SMEs are relatively simple in
their organizational structures and objectives. Usually SMEs take the form of a
private company, a partnership, or a joint stock company (Haahti and Pichler 1995).
42
Managers, who are identified in this chapter with the decision makers, are frequently
the owners of the firms that take the first two forms. Therefore, we assume that the
SME decision maker’s objective of entry mode choice is in line with that of the
SME as a whole in our model. Fundamental objectives of firms are growth and
development (Milgrom and Roberts 1992). The SME decision makers are
intentionally rational when they make their decisions under some constraints.
Therefore, the principle followed by the SME managers for their entry mode
decision is simply to maximize the expected aggregate profit of investment in both
the home country and host country through allocating its investment between the
two countries optimally. Therefore, the SME may or may not invest in the foreign
country. When the firm decides not to invest in the foreign country it may enter via
exporting or contracting (Anderson and Gatignon 1986). In case of an investment,
the SME can either cooperate with a foreign partner, i.e. to establish a JV, or form a
WOFV.
3.2.2 Notations and the model
Starting from the above considerations, we can make the following assumptions
to construct a simple framework for modeling entry mode choice.
1. The difference among different entry modes, e.g. exporting/contracting, a JV
and a WOFV, is essentially a difference of ownership (Anderson and
Gatignon 1986, Grossman and Hart 1986). To choose an optimal entry mode
the SME decision maker has only to determine the optimal ownership ratio
regarding the foreign country operation instead of comparing the expected
outcomes of different alternative entry modes. This ratio can be denoted by
θ , with [ ]0,1θ ∈ . This means that there is no limitation on the ownership
ratio θ in the host country, i.e. the policy constraint in the host country is
trivial. If 0θ = , the SME decides not to invest, alternatively, the SME enters
via exporting or contracting. If 1θ = , the SME enters via a WOFV;
otherwise, it enters as a JV.
2. The company has a simple production technology producing one output
( )q x with one input, i.e. capital x , by this we assume that other non-capital
43
inputs are numerated with cash. This technology holds a property of strict
concavity, i.e. 2 2( ) / 0q x x∂ ∂ < . This is to guarantee the uniqueness of
maximum output. Economically, the marginal productivity with respect to
input is decreasing. Furthermore, , f fq x denote the output and the input of
the production in the foreign country. fx > 0 can be forecasted and is given,
it might result from two sources, namely the investment of the SME (i.e.
f fx xθ= ) and the investment of its partner in the host country (i.e.
(1 ) fxθ− ). Analogously, and h hq x denote the output and the input of
production in the home country. The sum of the SME’s investment in the
two countries cannot exceed its capital capacity X . In addition, and f hr r
represent the capital cost rates in the foreign and home countries
respectively. Both foreign and home operations incur fixed costs of
investment fF and hF respectively.
3. The SME’s profits made abroad and at home are taxed separately without
any overlapping. The income tax rates in the host and home country are
denoted by ft and ht , with ft and [ )0,1ht ∈ .
4. Due to the size of SMEs, their markets for the outputs are competitive both
at home and abroad. The output price fp in the foreign country is assumed
to be a random variable, which is a standard normal distribution with mean
being µ and variance being 2σ . Due to prior experience the output price
hp in the home country is given. The prices of inputs in the home and host
country are given as well. The risk of operating abroad can thus be
represented by the variance 2σ of the output price (i.e. or by the standard
variance σ ).
5. The allocation of the profit of the joint project between the SME and its
partner in the host country, if the SME operates jointly with a foreign
partner, is assumed for simplicity to be dependent on nothing but the
ownership ratio θ . Therefore, its profit due to investment in the host
country is ( ) (1 )f f f f f f f fp q x r x F tπ θ = − − − . The home country profit
44
is ( ) (1 )h h h h h h h hp q x r x F tπ = − − − . The SME’s aggregate profit is
f hπ π π= + .
6. The company is characterized by a constant absolute risk aversion (CARA)
utility over the aggregate profit, i.e. ( )
0( )
U
U
π γπ
′′− = >
′ . U is monotonically
increasing and strictly concave with respect to π . γ is the parameter of risk
aversion, and it is constant due to the CARA utility function.
With the above assumptions, the decision-making problem can be described as
follows:
{ },Max E( ( ))
f hx xU π (3.1)
s.t. 0hx ≥ (3.2)
0fx ≥ (3.3)
f fx x≤ , with 0 < fx < X (3.4)
+f hx x X≤ (3.5)
The decision variables are explicitly fx and hx . Due to the fact that /f fx xθ = , θ
is therefore an equivalent decision variable of fx . Consequently, constraint (3.3)
and (3.4) are equivalent to [ ]0,1θ ∈ . The SME’s total investment cannot exceed its
capacity, X .
With the assumption that fp is the only (normally distributed) random variable,
we can conclude that fπ and f hπ π π= + have a normal distribution as well.
Therefore, the mean and the variance of π are:
( ) (1 )f f f f f f hq x r x F tπ θ µ π = − − − + (3.6)
22 2 2( ) (1 ) ( )f f fVar t q xπ θ σ = − . (3.7)
The assumption of CARA utility together with the normal distribution of the
aggregate profit give rise to a mean-variance utility function where the company’s
expected utility is a linear combination of the mean and the variance of the
aggregate profit (Sargent 1987). Therefore, we have:
45
{ } { }
{ }
, ,
22 2 2
,
( )Max E( ( )) Max
2
( ) (1 )
Max(1 ) ( )
2
f h f h
h
x x x x
f f f f f f h
f f fx
VarU
q x r x F t
t q xθ
γ ππ π
θ µ π
γθ σ
⇔ −
− − − + ⇔ − −
. s.t. 0hx ≥ , (3.8)
0θ ≥ , (3.9)
1θ ≤ , (3.10)
+f hx x Xθ ≤ . (3.11)
The corresponding Lagrangean function is
1 2 3 4
22 2 2
( , , , , , ) ( ) (1 )
( ) (1 )
(1 ) ( )
2
h f f f f f f
h h h h h h h
f f f
L x q x r x F t
p q x r x F t
t q x
θ λ λ λ λ θ µ
γθ σ
= − − −
+ − − −
− −
1 2 3 4(1 ) ( )h f hx X x xλ λ θ λ θ λ θ+ + + − + − −
(3.12)
The 1λ , 2λ , 3λ , and 4λ are nonnegative Lagrangean multipliers.
The first order conditions are:
1 2 3 4( , , , , , )0
hL xθ λ λ λ λθ
∂=
∂ (3.13)
1 2 3 4( , , , , , )0
h
h
L x
x
θ λ λ λ λ∂=
∂ (3.14)
The complementary slackness conditions are:
1 10, 0hxλ λ≥ = (3.15)
2 20, 0λ λ θ≥ = (3.16)
3 30, (1 ) 0λ λ θ≥ − = (3.17)
4 40, ( ) 0f hX x xλ λ θ≥ − − = (3.18)
Equation (3.13) and (3.14) can be transformed into:
46
22 2
2 3 4( ) (1 ) (1 ) ( ) 0f f f f f f f f f fq x r x F t t q x xµ γθ σ λ λ λ − − − − − + − − = , (3.19)
and 1 1 4( ( ) )(1 ) 0h h h h hp q x r t λ λ− − + − = respectively. (3.20)
1 ( )h hq x is the first order derivative, economically it is the marginal productivity in
the home country. To simplify the notations, we let
( ) (1 ),f f f f f fA q x r x F tµ = − − − 2
2 2(1 ) ( ) ,f f fB t q xγ σ = − and
1( ( ) )(1 ).h h h h hC p q x r t= − − Here , , and A B C have economic interpretations. A
can be interpreted as the expected profit of the project in the host country after tax
being paid, we note it simply as a net expected profit, similarly C is the net
marginal profit of investing in the home country, and fC x can be interpreted as the
opportunity cost of investing fx in the host country. B is the perceived risk of
investing in a foreign country.
3.2.3 Solutions
In order to find the optimal ownership ratio, which defines the optimal mode of
entry, and further to investigate how this optimal mode of entry is sensitive to the
external factors, we will solve this decision-making problem, which is described by
(3.1) - (3.5). We discuss firstly the corner cases, the boundary cases, and then the
interior case.
3.2.3.1 Corner cases
(1) * *1, ( ) 0 h= xθ = , and ( )* *f f fx x x Xθ= = <
In this case, the SME will not invest in the home country; it invests however in
the host country via a WOFV. Additionally, its investment in the host country, due
to the assumption, is lower than the capital capacity. The question remains to
identify the conditions under which the SME will decide to do so.
47
From Kuhn-Tucker theorem, * *( ) 0 , 1hx θ= = and ( )* *f f fx x x Xθ= = < induce
that ( ) ( )* *
2 4 0λ λ= = , ( ) ( )* *
1 3 0, and 0λ λ≥ ≥ . Inserting these optimal values into
Eq. (3.19) and Eq. (3.20) respectively, we obtain that
*3( ) 0A Bλ = − ≥ , (3.21)
( )*
1 0Cλ = − ≥ . (3.22)
Eq. (3.21) describes the situation that the net expected profit arising from
investing in the host country is at least not less than the SME decision maker’s
perceived risk of investing. Eq. (3.22) illustrates simply that the net marginal profit
of capital investment in the home country is not positive. This is to say that, in such
a situation, it is optimal for the SME to invest in the host country via a WOFV, but
not invest in the home country.
(2) * * * *0, ( ) = =0, and ( ) = 0f f hx x xθ θ=
In this situation, the firm will not invest in any country. Solving this problem, we
receive:
* *1 2( ) 0, ( ) 0λ λ≥ ≥ (3.23)
* *3 4( ) ( ) 0λ λ= = (3.24)
*1( ) Cλ = − (3.25)
*2( ) B Aλ = − (3.26)
This means that the SME will not invest in any country when the net marginal
profit of investing in the home country is non-positive, and the risk of investing in
the host country is not less than net expected profit. The results are understandable
and consistent with the practice.
(3) * * * *0, ( ) = =0, ( ) 0f f hx x x Xθ θ= = >
This case means that the SME decides to invest all of its capital in the home
country but not the host country. Again, we try to identify the conditions under
which this case could happen.
Similarly, we solve this problem and find that at this point there must be:
48
* *1 3( ) ( ) 0λ λ= = , (3.27)
* *2 4( ) 0, ( ) 0λ λ≥ ≥ , (3.28)
*4( ) Cλ = , (3.29)
*2( ) fC x Aλ = − . (3.30)
Eq. (3.29) simply indicates that the net marginal profit of investing in the home
country is non-negative, and Eq. (3.30) implies that the net profit arising from
investing in the home country is greater or equal to the net expected profit of
investing the same amount of capital in the host country. Under these two
conditions, it is better for the firm not to invest in the host country.
(4) * * * * * *1, i.e. 0 ( ) = = , ( ) > 0, and ( ) ( ) = 0f f f h h fx x x x x x Xθ θ= < + >
Solving this problem, we obtain:
* *1 2( ) ( ) 0λ λ= = , (3.31)
* *3 4( ) 0, ( ) 0λ λ≥ ≥ , (3.32)
*3( ) fA B C xλ = − − , (3.33)
*4( ) Cλ = . (3.34)
Eq. (3.33) means that the net expected profit arising from investment in the host
country less the sum of the perceived risks of the host country and the opportunity
cost of investing in the home country is non-negative. Eq. (3.34) illustrates that the
marginal profit of investment in the home country is not negative. If these two
conditions hold, the SME may invest in the host country as a WOFV while investing
in the home country as well, the total investment just uses up its capital constraint.
3.2.3.2 Boundary cases
(5) * * * *0, ( ) = = 0, 0 ( )f f hx x x Xθ θ= < <
In this situation, the SME decides not to invest in the host country and its
investment in the home country does not exceed its capital constraint. Again, solving
this problem results:
* * *1 3 4( ) ( ) ( ) 0λ λ λ= = = , (3.35)
49
*2( ) 0λ ≥ , (3.36)
*2( ) 0Aλ + ≥ , (3.37)
0C = . (3.38)
Inequality (3.37) and Eq. (3.38) illustrating that the net expected profit of
investing in the host country being not positive, and the net marginal profit of
investing in the home country being zero are the conditions of this investment
behavior.
(6) * * * * * *0 1, i.e. 0 ( ) = , 0 ( ) , and ( ) ( ) f f f h f hx x x x X x x Xθ θ< < < < < < + =
Through some manipulations, we obtain the explicit expression of *θ as:
* * *1 2 3( ) ( ) ( ) 0λ λ λ= = = (3.39)
*4( ) 0λ ≥ (3.40)
*fA C x
Bθ
−= . (3.41)
Simply, it means that when the net expected profit adjusted through opportunity
costs of investing in the host country, is less than the perceived risks of investing in
the host country, the SME will not invest via a WOFV.
3.2.3.3 Interior case
(7) * * * * * *0 1, i.e. 0 ( ) = , 0 ( ) , and ( ) ( ) f f f h f hx x x x X x x Xθ θ< < < < < < + <
In this case, the optimal strategy for the SME is to invest in both countries, in
particular via a JV in the host country. Solving this problem induces the following
results:
* * * *1 2 3 4( ) ( ) ( ) ( ) 0λ λ λ λ= = = = (3.42)
* A
Bθ = (3.43)
0C = (3.44)
Eq. (3.43) and (3.44) indicate that when the SME’s marginal profit of investing in
the home country becomes zero, and the net expected profit of investing in the host
country is less than the estimated risk, the optimal choice for the SME is to form a
50
JV. The optimal ownership ratio is the ratio of the net expected profit to the
perceived risk of investing in the host country.
The above different cases we have discussed can be simply depicted by the
following Figure 3.1.
Figure 3.1 The possible solutions to the optimization problem
3.3 Implications and propositions
3.3.1 Comparative static analyses
The boundary case (6), which is more consistent with reality, provides a solid
basis for practical implications that can be developed into concrete propositions to
support real entry mode choice decisions. To answer the question to what extent
interesting external factors influence entry mode choice, we have to look at *θ and
its relations to these factors more closely.
Let us start with the risk attitude of the decision maker. In fact, existing empirical
results have demonstrated that entry mode choice is related to risk aversion (Osland
θ ( fx ) X (1) (4)
1 ( fx ) (6) (7) (2) (3) (0,0) X hx (5)
51
et. al 2001, Bhaumik 2003). To go into this matter we first express *θ in case (6)
explicitly and differentiate it with respect to the risk adverse parameter γ , doing so
results:
** 1
2 2 2 2
( ( ) )(1 ) ( ( ) )(1 )0
(1 ) ( )
f f f f f f h h h h h f
f f
q x r x F t p q x r t x
t qγµ θθ
γ σ γ− − − − − −
= − = − <−
. (3.45)
Due to the fact that *θ is positive, we can conclude a negative relationship
between risk aversion and entry mode choice. This qualitative result is widely
accepted in the prior academic research as well as in practice. However, what about
the sensitivity of the optimal ownership ratio with respect to risk aversion? To
answer this question we can consider the elasticity of *θ with respect to risk aversion
parameter γ :
*
*
*1El
θ γ
θ γγ θ
∂= = −
∂. (3.46)
Obviously, a change of the risk aversion parameter γ leads to a proportional
change of the optimal ownership ratio *θ but in the opposite direction. With this
specification of the qualitative cognition, we can conclude the first proposition.
Proposition 3.1: Given a sufficient incentive to invest in the host country via
a JV ( *0 1θ< < ), then the more risk averse the decision maker is, the less
likely he adopts a high equity entry mode, such as a WOFV. A reduction of
existing risk aversion, e.g. due to a replacement of the decision maker with a
less risk averse one, leads to a proportional increase in the optimal
ownership ratio *θ .
The risk of an international engagement is represented in the model by the
variance of aggregate profit from foreign and home operations, which is incurred
mainly by the variance of the expected price in the host country market. To analyze
this relationship, we differentiate the optimal ownership ratio *θ with respect to the
standard deviation σ of the price. Given * 0θ > it is:
*
* 2 0σθ
θσ
= − < . (3.47)
52
To quantify this relationship we once again calculate the elasticity:
*
*
*2El
θ σ
θ σσ θ
∂= = −
∂, (3.48)
which indicates that a change in the estimated operation risk in the host country
leads to an over-proportional change in the optimal ownership ratio in the opposite
direction. Accordingly, the decision of entry mode choice is sensitive to the
estimated risk of the host country market.
Proposition 3.2: Given a sufficient incentive to invest in the host country via a
JV ( *0 1θ< < ), then the higher the estimated operation risk in the host country
is, the less likely the decision maker adopts a high equity entry mode, such as a
WOFV. A reduction in the estimated operation risk in the host country, e.g.
due to less uncertainty about the host country market as a result of learning
effects or due to the maturity of the host country market, leads to an over-
proportional increase in the optimal ownership ratio *θ .
Existing papers (e.g. Müller 2001, Eicher and Kang 2002) postulate that the
expected profit affects entry mode choice. In the above model, the opportunity cost
of investing fx in the home country is deducted from the expected profit of foreign
operation. This is the so-called “opportunity cost” -adjusted net expected profit,
which equals the following expression:
1( ( ) )(1 ) ( ( ) )(1 )f f f f f f h h h h h fadj q x r x F t p q x r t xπ µ= − − − − − − (3.49)
It is easy to see that when the net expected profit adjusted by the “opportunity
cost” is assumed to be a variable, it will be positively related to *θ :
*2 2 2
1
(1 ) ( )adj f ft qπθγ σ
=−
> 0 (3.50)
Furthermore, by calculating the elasticity of the optimal ownership ratio *θ with
respect to the adjusted net expected profit adjπ , we can describe the quantitative
relation between both as:
*
*
*1
adj
adj
adj
Elθ π
πθπ θ∂
= =∂
. (3.51)
53
This leads to proposition 3.3.
Proposition 3.3: The optimal entry mode choice is positively affected by the
“opportunity cost” -adjusted expected net profit of operation in the host
country market. The higher the profit a SME can gain by investing in the host
country compared with what it could earn by investing in the home country,
the more likely a high equity entry mode is adopted. A change in the adjusted
net expected profit adjπ leads to a proportional change in the optimal
ownership ratio *θ in the same direction.
As postulated by the American Marketing Association, the profit potentially
inherent in the structure of a market or industry could be measured by the
attractiveness of a market. In fact, many papers have studied, at least implicitly, the
influences of market attractiveness on entry mode choice by examining those factors
that could be used to measure market attractiveness. Such factors include, for
instance, market size (Chung and Enderwick 2001, Eicher and Kang 2002, Nakos
and Brothers 2002), and industrial barriers to entry (Siripaisalpipat and Hoshino
2000, Chen and Hennart 2002).
A close look at Eq. (3.49) tells us that the “opportunity cost” -adjusted expected
net profit of foreign operation is positively correlated with expected price µ and
expected sales ( )f fq x in the host country. On the other hand, it is negatively
correlated with income tax rate ft , fixed costs of investment fF , as well as cost
rate fr in the host country. Furthermore, the so-called “opportunity cost” of
investing fx in the host country is positively related to price hp and marginal
productivity 1 ( )h hq x 7; it is negatively related to income tax rate ht and capital cost
rate hr in the home country. Together with proposition 3.3 we can conclude that the
optimal ownership ratio *θ is positively affected by those factors which positively
contribute to the adjusted expected profit, in particular , ( ), f f hq x tµ , and hr .
Furthermore, it is negatively affected by factors , , ,f f f ht r F p , and 1 ( )h hq x . Factors
such as the potential sales, the output price, the income tax rate, the capital cost rate,
7 1 ( ) ( ) /h h h h hq x q x x= ∂ ∂
54
together with the estimated risk are meaningful measures of market attractiveness.
Therefore, we can make the following proposition describing the impact of the
market attractiveness on entry mode choice. Feenstra (1998) confirms this result by
explaining the American foreign direct investment (FDI) in China.
Proposition 3.4(a): The more attractive the host country market, the more
likely a SME adopts a high equity entry mode; vice-versa, the more attractive
the home country market in comparison with the host country market, the less
likely a high equity entry mode is adopted.
However, to know that there is a negative relationship between optimal ownership
ratio *θ and some observable factors, such as capital cost rate fr and income tax
rate ft in the host country, is just half of the story. The crucial question, not least in
view of strategic decision making in economic policy, is, how sensitive the optimal
ownership ratio is with respect to fr and ft .
By reformulating equation (3.41), we can show that *θ is a strictly downward-
sloping linear function of fr :
*
2 2
1
2 2 2
(1 )( ( ))
(1 )( ( ) ) (1 )( ( ) )
(1 ) ( ( ))
f f
f f f
f f f f h h h h h f
f f f
x r
t q x
t q x F t p q x r x
t q x
θγ σ
µ
γ σ
= −−
− − − − −+
−
(3.52)
To simplify this expression we let 2 2( )
0(1 )( )f
f
f f
xa
t q xγ σ= >
− and
1
2 2 2
(1 )( (( )) ) (1 )( ( ) )0
(1 ) ( ( ))
f f f f h h h h h f
f f f
t q x F t p q x r xb
t q x
µ
γ σ
− − − − −= >
−, therefore Eq. (3.52) can
be formulated as * far bθ = − + . Even though the slope of the linear function *θ is
constant, the elasticity varies along the respective curve (Perloff 2001). Thus, we
have three crucial cases:
a) If 0fr = then * 0bθ = > . This is the extreme when the other variables are
constant. At point (0, b) we get *
* *( / )( / ) 0f
f f
rEl r r
θθ θ= ∂ ∂ = , i.e. perfect
55
inelasticity. A moderate change of capital cost rate fr does not induce a
substantive change of *θ .
b) If ( / )fr b a→ > 0 then *θ → 0 given 0a > and 0b > . If ( / )fr b a= and all
the other variables are constant, we get *
* *( / )( / )f
f f
rEl r r
θθ θ= ∂ ∂ → −∞ ,
i.e., perfect elasticity. Thus a small decrease of fr induces a big jump in *θ .
c) Given a) and b) there must be a particular fr , for which * 1frEl
θ= − . After
some transformations, we find this occurs when ( / 2 )fr b a= and
* ( / 2)bθ = . Here a one percent increase of fr induces a one percent
decrease in optimal ownership ratio *θ .
The quantitative relationship between *θ and fr is depicted in Figure 3.2. The
higher fr , the more sensitive the optimal entry mode decision is, and the more the
SME decision maker should endeavor to prepare this decision accurately, e.g. by
taking into account special market studies or by consulting appropriate experts, in
order to minimize the risk of selecting a “wrong” mode. To avoid frustrating foreign
investors, decision makers in economic policy in the host country should be very
careful when thinking about increasing capital cost rates, i.e. interest rates. The
“critical” fr in this respect is where the elasticity is equal to -1 (see Figure 3.2). To
exceed this critical value may induce fatal effects on the investment climate. Below
this threshold, the choice of entry mode is less sensitive with respect to fr , i.e. the
SME decision maker can decide by concentrating on other factors. This leads to the
following proposition.
Proposition 3.4(b): Within the interval (0, /b a ), the capital cost rate fr –
ceteris paribus – induces a varying sensitivity of optimal ownership ratio *θ .
Meeting [ )0, / 2fr b a∈ entitles the SME decision makers to deal with the
choice of the entry mode more liberally due to the inferior elasticity. However,
if ( )/ 2 , /fr b a b a∈ the decision makers in SMEs as well as the economic
policy maker of the host country are well advised to pay special attention to
this factor due to its over-proportional negative effect on the optimal
56
ownership ratio *θ , and thus the overall investment behavior of foreign
companies.
Figure 3.2 Elasticity of optimal ownership ratio with respect to capital cost rate
0 ( )0, b/ 2b
/2b a
( / ,0)b a
* 0frEl
θ→
*1 0frE l
θ− < <
* 1frE l
θ= −
* 1frE l
θ< −
fr* fr
E lθ
→ − ∞
*θ
In an analogous manner we can also investigate the dependency of *θ on income
tax rate ft . The basis is the following elasticity:
*
* 2
* 2
( ) ( 2 )1
(1 ) ( ) ( 2 )f
f f f f
f f f ft
t t C A t A C tEl
t t A C A t C A t A Cθ
θθ
′ ′∂ − + − = = − = ′ ′ ′∂ − − + − + − , (3.53)
where (1 )f
AA
t′ =
−.
Having assumed that [ )0,1ft ∈ we can check how changes of ft within this
interval affect the sensitivity of the optimal entry mode choice. Again, we have to
consider three crucial cases:
a) If 1ft → then * 0θ → and * ftEl
θ→ −∞ (perfect elasticity). In this situation,
the other variables being constant, the SME will not invest in the foreign
country. At the same time, a small decrease in the current income tax rate
might induce a considerable increase of optimal ownership ratio *θ .
57
Consequently, countries with comparatively high income tax rates can affect
the long-term willingness of SMEs to think about high equity entry modes by
reducing the income tax rate level, at least moderately.
b) If 0ft = then ]* 2 2[( ) /( ( ) )] (0,1fA C qθ γ σ′= − ∈ and * ftEl
θ0= (perfect
inelasticity). If the income tax rate decreases to 0, the optimal ownership
ratio approaches its maximum. However, this maximum is not inevitably
equal to 1. In fact, it depends on other variables such as the adjusted
expected profit adjπ , the risk aversion parameter γ , the potential sales
( )f fq x , and the estimated risk 2σ . If ft is near 0, a small change in ft does
not induce appreciable changes in *θ .
c) Given a) and b) there must be a particular ft , where * ftEl
θ1= − . This applies
for ( ) /( )ft A C A C′ ′= − + . From *0 1θ< < , we get 0A C′ − > and can
conclude that (0,1)ft ∈ . The corresponding optimal ownership ratio is
* 2 2 2 2(( ) ) /(4 ( ( )) )f fA C C q xθ γ σ′= − .
The quantitative relationship between *θ and ft is summarized in Figure 3.3
(for simplicity we ignore the exact form of the curve with respect to ft ). The curve
indicates that the higher the income tax rate ft , the more sensitive the optimal
ownership ratio is, and the more the SME decision makers should pay attention to
this factor. When ft approaches 1 neither JVs nor WOFVs can be considered, i.e.,
without any objectives besides profit maximization a SME would not invest in the
host country. On the other hand, the lower the ft is, the less sensitive the optimal
entry mode is. Nevertheless, as shown above, ft → 0 does not imply that WOFV is
the optimal entry mode. In this case, other factors have to be taken into account.
This leads to our last proposition.
Proposition 3.4(c): With other variables being constant, a change in ft from 0
to 1 induces a varying sensitivity in optimal ownership ratio *θ with respect to
ft . In particular, if ft is lower than a “critical” value ( ) /( )A C A C′ ′− + , the
optimal entry mode is less dependent on ft but more dependent on other
factors, to which the SME decision makers should pay attention. On the other
58
hand, if ft exceeds this threshold, one should be aware of the possible effects
of ft on the optimal entry mode. The same applies for economic policy in the
host country regarding the implications for the foreign investment climate.
Finally, when ft takes a value close to 1, a non-equity entry mode should be
taken into consideration, unless there are some relevant non-profit objectives.
Figure 3.3 Elasticity of optimal ownership ratio with respect to income tax rate
(0,0)
2 2
2 2
( )
4 ( ( ))f f
A C
C q x σ
′ −
3.3.2 Comparison with prior results
The present chapter follows the prominent concept of understanding a firm’s
boundary issue as an optimal ownership allocation problem, taking into account both
the benefits and the costs of control as suggested, e.g. by Grossman and Hart (1986),
Hart and Moore (1990), and Feenstra and Hanson (2004). There are also some other
papers, such as the recent one by Helpman et al. (2004), which is based on
Grossman and Hart’s (1986) concepts too. However, some evident differences,
especially those regarding the implications resulting from the respective models, are
worth mentioning.
Helpman et al. (2004) treated the choice between export and FDI as a proximity-
concentration trade-off problem, in the course of which the decision is made by
comparing the relevant benefits and costs of each alternative. By assuming a simple
*θ
*1 0ftEl
θ− < <
* ftE l
θ→ − ∞
* 1ftE l
θ= −
* 1ftEl
θ−∞ < < −
*0 ftEl
θ< < ∞
2 2( ( ))f f
A C
q xγ σ
′ −
A C
A C
′ −′ +
1
ft
59
constant elasticity of substitution (CES) preference form and unit wages in every
country, the authors expressed the net profit of each alternative, namely domestic
sales, export, and FDI. The equilibrium conditions in their context yields the cutoff
productivity points of each alternative, which explains high productivity induces
more FDI and less export (e.g. see the figure in Helpman et al. 2004 p. 302).
Therefore, by means of comparative static analysis together with an empirical study,
the authors concluded that high productivity, high trade friction, and high firm
heterogeneity induce more FDIs. In contrast to our approach, Helpman et al. (2004)
started with the existence of different alternatives of conducting business: domestic
sales, export, and FDI. However, the choice is made mainly between export and
FDI. Our approach starts from an ex ante unclear form of doing business overseas
which is explicitly determined by the ownership ratio. The focus generalizes to all
possible alternatives, i.e. from the lowest equity modes to the highest equity modes.
On the other hand, we converge by applying the concepts of cost-benefit-risk to
structure and analyze the model. In fact, the results of Helpman et al. (2004) are
more predictive in terms of organization (e.g. productivity) and industrial structure,
whereas ours are more predictive with regard to the decision maker and the country
environment.
3.4 Discussion
SMEs’ entry mode choice is modeled with a neoclassical method. The underlying
reasons or advantages of modeling like this are twofold. Firstly, the SMEs are
usually small in size and have a simple organizational structure, e.g. the owners are
usually the managers; therefore one can assume that the firm as a whole makes
strategic decisions without incurring any agency cost (Milgrom and Roberts 1992).
Secondly, modeling like this allows us to investigate in depth, not only how the firm
interacts with its external environment (e.g. tax, interest rate), but also how the
decision maker himself influences the decision-making. One might doubt the
expedience of this model in comparison with the existing game theoretical ones
when it is evaluated separately. As a matter of fact, this model is more close to
reality in respect to SMEs; in particular, it is an indispensable part of our systematic
60
model, in which the interactions among the decision maker, the organization, and the
environment are highlighted in the process of decision-making.
Of course, the SMEs’ entry mode choice could be modeled differently. In our
model, the choice of entry mode is made by a one-shot decision of optimal
ownership ratio; however, in practice this decision might involve a multiple-stage
analysis, in which the latter-stage decision is made by taking the result of the
former-stage into account (Kumar and Subramanian 1997). Therefore, the analysis
could be based on a continuous time scenario.
The implications of how exogenous factors influence entry mode choice in our
model are derived with a sensitivity analysis. This method allows identifying the
impact of one independent variable on the decision variable, but it ignores the
impact of other independent variables on the dependent variable (Varian 1999).
Actually, as we have analyzed in chapter 2, entry mode choice is dependent on the
simultaneous impacts of various factors. Therefore, other methods, e.g. a scenario
analysis suggested by Ross et al. (2005), might deduce other implications in our
context.
Tax plays an important role in financial decisions as well as in the form of an
organization (i.e. sole proprietorship, partnership, JV or WOFV)(Weston and
Copeland 1992). Tax changes the firm’s financial structure through leveraging (Ross
et al. 2005). Therefore, introducing leverage (i.e. financial market) into our model
might induce more theoretical and practical implications. In addition, as we have
concluded, the host country government might take some measures to attract foreign
direct investment, e.g. tax subsidies. The interesting point is to analyze how tax
subsidies will influence the demand and supply of foreign direct investment as well
as the change of social surplus of the host country. Microeconomic theories have
provided a profound foundation for such an analysis (Varian 1999).
Interest rate is a central part of financial management as well, since it represents
the opportunity cost of investment. The consideration of interest rate can not be
separated from the firm’s internationalization, e.g. entry mode choice (Ross et al.
2005). If we adopted a multiple-stage model of decision-making, the impact of
61
interest rate on entry mode decision will be based on a continuous time horizon
(Weston and Copeland 1992).
3.5 Conclusion
By analyzing the existing theories as well as empirical studies on entry mode
choice, we found an explicit need for models suited to the SMEs. Starting from
relevant characteristics of SMEs we developed a simple mathematical model, which
indicates how the choice of entry mode could actually be made. In this model, the
decision maker maximizes his utility of decision-making by choosing an optimal
endogenous ownership ratio that defines the entry mode. Special attention was
devoted to the investigation of qualitative and quantitative relationships between the
optimal ownership ratio and some important factors. These factors have been
explored from different aspects, in particular those of the decision maker and the
economical environment, in which the former is embedded. In addition, in
comparing the differences between our results and those of comparable models, the
differences seem to arise from different model structures and assumptions. By
analyzing the quantitative relationships between the optimal ownership ratio and the
factors considered, we were able to draw some useful conclusions for decision
makers in economic policy in view of an active stimulation of foreign investments.
However, the explanatory power of the model strongly depends on the underlying
assumptions. Relaxing one or more of our assumptions could possibly lead to
alternate implications. For example, if we relax the assumption that the decision
maker’s objectives are in line with those of the company that he is representing, then
we have to consider managerial discretion. In addition, entry mode choice could be
explained differently if we consider the situation that, the allocation of the profits
between the SME and its partner is dependent not only on the ownership ratio but
also on other factors, e.g. the power of each party. Last but not least, the assumption
on decision maker’s CARA is not completely reasonable in practice, replacing it
with a Constant Relevant Risk Aversion (CRRA) might induce other implications.
62
Chapter 4 Large Firms’ Market Entry Mode Choice: Managerial Discretion and Expense Preference
In chapter 3 the SMEs’ entry mode choice is modeled in a context of competitive
markets for inputs and outputs, together with an alignment of management and
ownership. However, in practice, many large firms are not operating in such an
environment. There is an explicit separation of ownership from management as well;
the markets for outputs and inputs in the host or the home country may not be
perfectly competitive at all. The question that remains unclear is how large firms
should choose their entry mode in such a situation.
The separation of ownership from management and a non-perfect market have at
least two significant consequences, e.g. a complex organization structure and
thereby specialization, and the existence of managerial discretion and managerial
expense preference (Williamson 1965, Leibenstein 1966, 1975, Jensen and Merkling
1976, Milgrom and Roberts 1992, Jensen 2000). This chapter aims therefore to
study how large firms’ entry mode choice will be made in the framework of these
consequences.
The remainder of this chapter is structured as follows. Section 4.1 introduces the
consequences of the separation of ownership from management. Section 4.2
explains the framework of the new managerial discretion model of entry mode
choice. Section 4.3 describes the strategic decision of entry mode choice by the
board of directors. Section 4.4 presents the managers’ tactic decisions and the
possible deviation from profit maximization in the process of implementing the
strategic decisions made by the board. Section 4.5 concludes this chapter with a
comparison of our model and the results with the existing literature and an outlook
for future research as well.
63
4.1 Separation of ownership from management
4.1.1 Two significant consequences
The separation of ownership from management has been widely acknowledged in
the existing literature (Williamson 1965, Jensen and Merkling 1976, Milgrom and
Roberts 1992, etc.). One of the most significant consequences arising from the
separation of ownership from management is the complex organizational structure
and thereby the specialization. In such a complex organization, the board of
directors usually makes some strategic decisions on behalf of the shareholders, and
monitors the performance of the managers to guarantee the realization of the
shareholders’ desires. The managers, not like those in the SMEs, are not the residual
value receiver anymore; they work on salaries, rewards and other private interests.
Their effort focuses on implementing the strategic decisions by making tactic
decisions.
Another significant consequence is the conflicting interest and incentive of
managers and shareholders over a firm’s strategic issues such as market entry
(Williamson 1965, Leibenstein 1966 and 1975, Jensen 1986, 2000). The managers,
in such a context, will have great latitude of decision-making in the process of
implementing the strategic decisions made by the board, which allows them to
employ and/or allocate resources in favor of private interests at the cost of the firm’s
benefits. This great latitude of decision-making is defined as managerial discretion
(Williamson 1965, Jensen and Merkling 1976, Milgrom and Roberts 1992, Jensen
2000). Additionally, the managers, being not the residual value receivers for firms’
economic activities, might pursue a strategy of maximizing personal utility by
favoring excessive expenses in salaries, a larger staff, unnecessary rewards,
privileges, office settings, etc. Not like those in traditional economics, the managers
take therefore a positive attitude toward these expenses and this phenomenon is
called expense preference (Williamson 1965, Leibenstein 1966 and 1975, Tosi et al.
1999).
64
4.1.2 Managerial discretion models
Economists have long debated the large firms’ objectives for decision-making.
Papandreou (1952) argued that profit maximization was an unnecessary special
assumption and that a more fruitful theory of the firm should employ a general
preference function. Many other economists have introduced various managerial
discretion models to challenge the traditional profit-maximization hypothesis, e.g.
the utility maximization model by Williamson (1965), the revenue maximization
model by Baumol (1967), and the growth maximization model by Marris (1964).
The various managerial discretion models differ from each other in terms of the
objective function, the constraints, or even both. Non-perfectly competitive markets
considered in a decision-making context together with the separation of ownership
from management have been stressed as the reasons for the large firms’ deviation
from profit maximization (Williamson 1965, p.39).
Williamson’s (1965) utility maximization model intended to present a general
preference function as suggested by Papandreou (1952). The model suggested that in
manager-controlled firms, the manager’s utility of decision-making is dependent not
only on the firm’s value but also on his pecuniary and non-pecuniary benefits, which
can arise through the managerial discretion of resource allocation. The core concept
of Williamson’s managerial discretion model is expense preference.
Rees (1974) extended Williamson’s model by introducing three different
possibilities of staff expenditure indulgence. In addition, Yarrow (1976)
theoretically advanced the managerial discretion model by standardizing the
constraints. Furthermore, a wide range of studies supported the existence and the
significant impact of managerial discretion and managerial expense preference on
firms’ strategic decision-makings, empirically and theoretically. See Edwards
(1977), Hannan (1979), Awh and Walter (1985), Drake (1995), Bertero and Rondi
(1998), Hasan and Lozano (1999), Yung (2001), Gropper and Hudson (2003),
Rodriguez and Lovell (2004), and Morellec (2004) for example.
Managerial discretion of revenue maximization instead of profit-maximization has
also been widely identified since the original work by Baumol (1967). Nava and
Nitzan (1988) developed this revenue-maximizing model by replacing the constraint
65
of a minimum profit level with a maximum one. Blinder (1992 and 1993) provided a
pure revenue maximization hypothesis in explaining why Japanese firms can win
American firms in their bilateral trades. Empirically, Deneffe and Masson (2002)
tested the hypothesis of profit maximization on hospitals and concluded (resulting
from regression analysis) that hospitals maximize a combination of profits and size
(number of patients).
The concepts of managerial discretion and expense preference have been and
continue to be applied to discuss firms’ strategic decisions. For example, they are
frequently discussed in the literature of managerial compensation (Yun and Mueller
1997, Finkelstein and Boyd 1998, Tosi et al. 1999), and other strategic operational
decisions, e.g. acquisition by Yung (2001). In these articles, managerial discretion
and expense preference are found to be significant drivers of the distortion of the
organizational goal of profit maximization.
Explicitly, there are numerous literatures, which have studied the impact of
managerial discretion and expense preference on firms’ strategic decisions.
However, only sporadic literature has taken the first consequence of the separation
of ownership from management, i.e. the specialization, into consideration in the
process of firms’ decisions. Additionally, the application of these two consequences
for a firm’s entry mode decisions is even scarcer (Stulz 1990, Yung 2001). This
scarcity, however, does not indicate a lack of significance.
4.2 The framework of large firms’ entry mode choice model
4.2.1 Managerial discretion of the revenue maximization
As is widely accepted, the manager has private interests during the process of
decision-making, which may be inconsistent with those of the firm. The decision
maker’s private benefits are composed of two parts, pecuniary and non-pecuniary.
The pecuniary part includes those like salary, bonus, and rewards among others. In
the corporate compensation system, the salary is usually fixed and is independent of
a specific decision made by the manager (Williamson 1965). However, the rewards
and other variable compensations, as considered later, are usually dependent on the
66
revenue increment. This variable pecuniary compensation motivates the decision
maker to direct their discretion in favor of their private interests, which is usually at
the cost of the firm’s profit maximization. Therefore, we assume that the manager’s
utility is dependent on the firm’s revenue. The existing literature as well as the
practice, as explained in the following, justifies this assumption.
Managerial compensation is usually related with revenue increment rather than
profit (Wildsmith 1973, Jensen 1986). A motivation of revenue increment rather
than profit maximization accelerates foreign market entry, and even the choice of
entry mode. Jensen (1986) argued:
“Managers have incentives to cause their firms to grow beyond the optimal
size. Growth increases managers’ power by increasing the resources under
their control. It is also increased with increases in managers’ compensation,
because changes in compensation are positively related to the growth in
sales” (Jensen 1986, p.324-5).
This favor of revenue increment is confirmed by a recent survey executed by IBM
in 2004. This survey report8 reads as:
“NEW YORK--IBM detailed on Monday the results of a survey indicating
that CEO priorities have shifted from cutting costs to generating more
revenue. Based on face-to-face interviews with about 450 CEOs and
business unit heads of large global companies, the survey showed that
corporations would feel comfortable investing in new ventures this year in
order to drive new revenue growth. Asked to prioritize how companies plan
to strengthen their financial position, CEOs indicated that revenue growth
would take precedence over cutting costs. This is a shift from the priorities in
the 2003 study, when most business managers focused more on wringing
costs out of existing businesses to weather the economic downturn, IBM said.
In Europe and Japan, however, top executives showed about equal emphasis
on cost cutting and revenue growth, the 2004 survey showed”.
8 By Martin Lamonica, CNET News.Com, published on ZDNet News: Feb 24, 2004.
http://news.zdnet.com/2100-3513_22-5163955.html
67
However, this revenue increment preference is subject to some constraints. As the
top executives in Europe and Japan reported, both the cost cutting and revenue
growth are points to concern. Therefore, a minimum profit level is at least one of the
constraints to this revenue increment preference.
4.2.2 Expense preference
In respect to the manager’s non-pecuniary benefits, as Williamson (1965) listed,
the feeling of dominance, security and professional excellence are those mostly
reported to be significant. The feeling of dominance is dependent on status, power,
and prestige. The realization of the feeling of dominance is achieved mainly through
the empowering of the manager. This empowerment, in the context of entry mode
choice, is obtained by a higher level of control in the cooperation with a foreign
partner. However, a higher control of foreign operation exposes the firm to higher
risk (Anderson and Gatignon 1986); consequently, this higher risk brings a higher
expenditure for control. In addition, the managers usually give more attention to
security in an unstable environment (Williamson 1965). Again, the realization of
security is not costless. Therefore, the manager’s non-pecuniary benefits cannot be
realized without the sacrifice of the firm’s benefits.
Due to the information asymmetry and the latitude of decision-making in the
process of entry mode choice, the manager has the possibility of spending some
extra costs on, (i.e. which should have been used to improve the firm’s performance)
or allocating a part of the firm’s value to, his private interest.
Of course, the manager cannot do whatever he wishes. Besides his private
benefits, the manager cannot completely ignore the firm’s benefits. Over
emphasizing private interests in the process of decision-making may induce, as a
result, a bad performance. This can lead to a takeover, and therefore the loss of
employment. The most frequently applied constraints are those such as a minimum
level of profit, firm value, or a maximum cost level.
68
4.2.3 Definition of entry modes
Grossman and Hart (1986) proposed that corporate governance could be defined
by the ownership of the firm. Sequentially, Anderson and Gatignon (1986) classified
entry modes into two types, namely high-equity modes and low-equity modes,
according to different levels of ownership. Additionally, in chapter 3, we have
defined entry modes by an endogenous variable, i.e. the ownership ratio of the joint
project in the host country. A high ownership ratio interprets a high equity entry
mode, such as a WOFV, a low ownership ratio means a low equity entry mode, such
as a JV.
Additionally, to enter into a foreign market via a WOFV, there are at least two
options, i.e. to establish a WOFV by the investing firm itself, this, in the existing
literature, is usually defined as a Greenfield WOFV, or by acquiring a local firm
(Buckley and Casson 1998, Görg 1998). In this chapter, the investing firm is
assumed to have decided to invest in the home and host country. Therefore, he has to
decide to either enter via a JV, a Greenfield WOFV or even via acquiring a local
firm.
The only difference between entering via a JV with the local firm and entering via
acquiring the local firm is assumed to be the premium involved for the acquisition
activities. Additionally, the investing firm is usually assumed to have a more
superior technology than that of the local firm (Mueller 2001). Therefore, the
investing firm will adopt its own production technology no matter under which entry
mode. The difference between the two entry modes and a Greenfield WOFV is the
different market structure faced by the investing firm, and the impact of the
coexistence of different technologies on the market.
4.2.4 The structure of market and time
Before the investing firm enters into the host country, there is one monopolistic
firm in the host country producing the same product as the investing firm. The
investing firm operates in a competitive market in its home country. If the investing
firm has decided to invest via cooperating with or acquiring the local firm, then it
plays as a monopoly in the host country market. By this, we simply assume that the
69
local firm in the host country will vanish after the investing firm’s entry via a JV or
via an acquisition. Therefore, the investing firm will have a similar market structure
no matter whether it forms a JV or acquires the local firm. On the other hand, if it
has decided to invest via a Greenfield WOFV, then it competes and plays a Cournot
game with the local firm in the host country market.
In the first stage, the board of directors (i.e. on behalf of the firm) decide the mode
of entry strategically (i.e. sets a certain interval of ownership ratio), and set a
minimum profit level given their understanding of the market and technologies. This
decision is made under assumption that the firm cares more about the development
of the firm, i.e. profit maximization (Milgrom and Roberts 1992). In the second
stage the managers decide the concrete volume of investment given the decisions
made by the board in the first stage. In contrast to the board of directors, the
managers care more about their benefits, pecuniary or non-pecuniary, than the firm’s
profit. Therefore, in the process of deciding the concrete volume of investment, the
managers intend to maximize their utility of decision-making.
4.3 The strategic decision of the board
4.3.1 Notations and assumptions
For the sake of simplicity, we assume that the board makes the choice of entry
mode by considering the profitability of each alternative only. Additionally, due to
information asymmetry, the board of directors makes the strategic decisions based
only on the estimates of the market demand and the firm’s technology. No other
firm, except for the investing firm, will enter into the host country market. The two
firms produce homogenous products and sell all the products produced without
storage. Additionally, we assume that the directors do not know in advance if the
managers will employ a portion of expenditure or firm value for their private
benefits.
1. Assume the board estimates an inverse market demand function, p a bq= −
when it plays as a monopoly, and 1 2( )p a b q q= − + when it plays as a
70
duopoly, where a is positive and constant. Without loss of generality, we
assume 1b = , which implies the slope of demand curve is -1.
2. θ , the ratio of the investing firm’s investment in the foreign country, is
defined as ( ]0,1θ ∈ . * (0,1)θ ∈ indicates an entry via a JV, and * 1θ =
implies an entry via a Greenfield WOFV or an acquisition.
3. The investing firm is assumed to have a superior technology with marginal
production cost 1 0c > . On the other hand, the local firm is assumed to have
an inferior technology with marginal production cost 2c > 0, therefore we
have 2 1 0c c> > (Mueller 2001). No matter which mode the investing firm
adopts, it will produce with its own superior technology. m is the premium
arisen from the acquisition activity. Therefore, to the knowledge of the
board, the estimated cost of the investing firm’s operation in the host country
consists of production cost and acquisition premium if it happens. If the
investing firm has decided to invest via the other mode rather than
acquisition, then the premium m takes null.
4.3.2 The profit of investing via JV
By assuming that the allocation of the profit between the investing firm and its
partner is according to the ownership ratio only, the profit function of the firm is
therefore:
[ ]1 1JV pq c qπ θ= − , with p a q= − , (4.1)
where q is market supply. Solving this problem, we obtain:
* 1 ,2
a cq
−= (4.2)
* 1 ,2
a cp
+= (4.3)
and 2
* 11
( )( )
4JV a c
π θ−
= . (4.4)
71
As the JV is a monopolist in the market, it will decide the quantity of supply and
the correspondent price as (4.2) and (4.3) respectively to maximize its profit. The
investing firm’s profit due to its investment is therefore the expression of (4.4).
4.3.3 The profit of investing via acquisition
The only difference between acquiring the local firm and forming a JV with the
local firm has been assumed to be the cost premium m of the acquisition activity.
Therefore, the results have similar structures with above analysis, and they are:
1 1( )acq pq c q mπ = − − , with p a q= − , (4.5)
* 1
2
a cq
−= (4.6)
* 1 ,2
a cp
+= (4.7)
and 2
* 11
( )( )
4acq a c
mπ−
= − . (4.8)
Similarly, to obtain a maximum profit, the new firm as a monopolist (after
acquisition of the local firm) will supply the quantity of (4.6) at price of (4.7). The
investing firm’s profit due to its investment is therefore expressed by (4.8).
4.3.4 The profit of investing via Greenfield WOFV
The investing firm has a profit function:
1 1 1 1 1 2, with ( )WOFV pq c q p a q qπ = − = − + , (4.9)
where 1 and are the supplies of the two firms.2q q The local firm’s profit function is
2 2 2 2 1 2, with ( )pq c q p a q qπ = − = − + . (4.10)
Solving this problem, we obtain:
* 2 11
2,
3
a c cq
+ −= (4.11)
* 2 12
2,
3
a c cq
− += (4.12)
72
* 1 2 ,3
a c cp
+ += (4.13)
and 2
* 2 11
( 2 )( )
9WOFV a c c
π+ −
= . (4.14)
Differently, when the investing firm established a Greenfield WOFV in the
foreign country, it will compete with the local firm for the market, i.e. they will play
a Cournot game. (4.11) is the investing firm’s optimal supply to the market via
taking into account the quantity of supply by the local firm. (4.12), similarly, is local
firm’s optimal quantity of supply. As a result, the investing firm’s maximum profit
is expressed by (4.14).
4.3.5 The choice of entry mode strategy
To make the strategic choice of entry mode, the board compares firstly with the
two alternatives of cooperating with the local firm, i.e. either via a JV or via an
acquisition.
Due to the same market structure after cooperation, Eq. (4.4) and (4.8) (i.e. the
profits of these two alternatives) have a similar structure. Intuitively, if the investing
firm is in the majority in the JV, i.e. θ is near its maximum value 1, the local firm is
very small, and if the cost premium of acquiring the local firm is not so low, then the
profit by investing via a JV may be much higher than that by acquiring the local
firm. On the other hand, if the investing firm is very small, the local firm is large and
in the majority in the JV, and if, the premium of acquisition is not so high, then the
profitability of acquiring the local firm will be higher than that of forming a JV.
Therefore, we can conclude that the firm’s entry mode strategy is dependent on the
firm’s size and the premium of acquisition.
Then the firm compares Eq. (4.4) with Eq. (4.14), i.e. the profits of the JV and
Greenfield WOFV respectively. Eq. (4.14) indicates that the profit of the Greenfield
WOFV depends on the marginal costs of the two firms, in other words, their
production technologies.
Firstly, we consider no big gap between the two firm’s technologies, i.e. 1 2 and c c
are approximately equal. Then Eq. (4.14) can approximately read as
73
2* 1
1
( )( )
9WOFV a c
π−
= . In this case, if the investing firm cooperates with the local firm
via a half-half model, i.e. 1
2θ = , or even θ is a little bit smaller than half, the
investing firm can still make more profit via forming a JV with the local firm.
However, if the investing firm has a much superior technology, i.e. 2c is much
higher than 1c , then the profit acquired by investing via a WOFV may be greater
than that of a JV with the local firm being in the majority. Intuitively, even if the
investing firm is not so large, the advanced technology and thereby the cost
advantage can still earn it a large market share and consequently a prosperous profit
after entry. Therefore, it will be worthwhile of entering by itself.
Obviously, if the local firm has a superior technology (even this is usually not the
case in practice, and it is contradictory with the previous assumption), the investing
firm will find it more favorable to cooperate with the local firm rather than to enter
by itself.
To compare Eq. (4.8) with Eq. (4.14), we first transform Eq. (4.14) to
2* 1 2
1
( (2 ))( )
9WOFV a c c
π− −
= . It is not difficult to identify that if the investing firm
makes more profit via a Greenfield WOFV, then there should be a significant
difference between 1 2 12 and c c c m− + , or equivalently, a large gap between
1 2 and c c m− . This could occur in two cases, i.e. either the technology gap is
significant or the acquisition premium is very high.
Therefore, to summarize we write the first proposition as
Proposition 4.1 The firm’s entry mode choice is influenced by the market
structure before and after entry, what technologies the firms have, the firm
size, and the incurred costs during the process of market entry.
This finding is consistent with Buckley and Casson (1998) and Görg (1998),
however, this finding complements their conclusions by considering the firm size
and the costs incurred in the process of market entry.
74
4.4 The managers’ tactic decisions
4.4.1 Notations and assumptions
As analyzed above, due to the separation of ownership from management, the
managers have a desire and ability of spending extra expenditure on or allocating a
portion of the firm’s value to private interests at the cost of the firm’s profit. To
investigate how the managers’ expense preference and managerial discretion may
drive their decisions to deviate from the firm’s goal of profit maximization, and how
the external constraints, such as a minimum profit requirement set by the board of
directors, can correct the deviations, we make the following assumptions and
notations.
1. Assume for simplicity that the board of directors, in the first stage, has
decided strategically to enter via a JV, this means that the investing firm will
be a monopolist in the host country market after entry. The board has defined
a certain interval of ownership ratio for the joint project, and has set a
minimal expected profit 0π for the managers to achieve. Given the decisions
made by the board, the managers will decide tactically, in the process of
implementation, the concrete volume of investment by taking the overall
performance, both at home and abroad, into account.
2. The JV has a same simple production technology ( )f fq x , and fx is the
only input. and f hr r , and fF and hF are defined in a same way as that in
chapter 3. Additionally, ( ) ( ) ( )f f f f f fq x q x q xθ θ= = is the investing firm’s
portion of output due to its investment in the host country.
3. The actual cost incurred in the host country, fC , is now a function of the
extra (discretional) expenditure, S , which is employed by the managers to
create private benefits, the production costs, and the acquisition premium if it
happens, i.e. ( , , )f f fC r x S m , where 1fc r= . Assume further that fC is
strict convex function of S . The impact of the increase of S on the cost fC
is therefore twofold: it decreases the total cost due to its positive contribution
to production efficiency, however if it is too high, it may also increase the
75
total cost. In case of the investing firm enters via a JV, S is undertaken only
by the investing firm but not by its foreign partner. Therefore, as analyzed
later, the impact of the increase of extra expenditure on output price and
revenue in the host country are twofold too. Due to information symmetry,
the investing firm’s operation in the home country does not incur any other
cost rather than production cost. ( )h hC x represents the cost in the home
country.
4. ( )f fp C is the output price in the host country set by the managers, and hp
is the output price in the home market, which are non-negative and given.
fp is assumed to be a strict concave function of fC , i.e. 2 2/ ( ) 0f fp C∂ ∂ < .
Hereafter the abbreviation fp will be applied for simplicity.
5. fR and hR are the investing firm’s revenues due to its investments abroad
and at home respectively, with ( ) ( )f f f f f f fR p q x p q xθ= = ,
( )h h h hR p q x= . The investing firm’s aggregate revenue is f hR R R= + .
Therefore, we can assume that R is a function of the investing firm’s capital
investments, f fx xθ= and hx in the two countries and the extra expenditure
S while keeping the other variables constant, i.e. ( , , )f hR x x Sθ . In addition,
assume R is a strict concave function of the extra expenditure, S .
6. 0, 0h fx x X> < < , and f h f hx x x x Xθ + = + ≤ , where X represents the
investing firm’s capital capacity too. These assumptions simply indicate that
no matter which mode the board of directors decides to use, the investing
firm’s capital investment in two countries cannot exceed its own capital
capacity.
7. β is the portion of the firm’s benefits, e.g. revenue, employed by the
managers for emolument (Williamson 1963), and 0 1β< < .
8. ,f ht t are again defined in a same way as we did in chapter 3.
76
9. ,f hπ π are the firm’s profits from its investments abroad and at home
respectively, ( ))(1 )f f f fR C tπ = − − , and ( )(1 )h h h hR C tπ = − − . The firm’s
aggregate profit from this investment decision is f hπ π π= + .
10. 1( , ( , , ))f hU S R x x Sθ is the manager’s utility function of decision-making.
The utility function is composed of two components, namely the discretional
extra expenditure and the revenue. In addition, we assume that U takes a
simple linear form: ( , ( , , )) ( , , )f h f hU S R x x S S R x x Sθ β θ= + . Therefore, the
manager’s utility is positively related to the discretional expenditure and the
revenue.
4.4.2 The managers’ decision-making problem
With the above setup, the managers’ decision-making problem can be expressed
as:
{ }, ,Max ( , ( , , ))
h
f h
S xU S R x x S
θθ (4.15)
s.t. 0 0π π− ≥ , (4.16)
θ θ≤ , (4.17)
0θ > , (4.18)
0hx ≥ , (4.19)
0S ≥ , (4.20)
f hx x Xθ + ≤ . (4.21)
Inequality (4.16) indicates that the consequent profit due to the managers’
decision of investment should be at least not less than the minimum profit set by the
board. (4.17) and (4.18) explain that the ownership ratio (i.e. thereby the volume of
investment) should be in the interval preset by the board as well. Therefore, (4.16),
(4.17) and (4.18) can be interpreted as the “behavioral constraints” preset by the
board. The manger’s decision will be evaluated in particular by the minimum profit
requirement; not meeting this criterion induces a replacement or punishment. With
inequality (4.17) and (4.18), we assume that the board has defined in the first period
77
that (0,θ θ ∈ . Of course, one can also assume that ,θ θ θ ∈ , where θ > 0. The
constraint (4.21) is a “budget constraint”, i.e. the firm’s investment cannot exceed
this capital capacity. To maximize his utility through increasing revenue, the
manager will always utilize all the available capital capacity, in another words, the
constraint is always binding, i.e. f hx x Xθ + = . We can therefore safely replace this
equation into the objective function without losing any generality. Remember, we
have also assumed that the firm has decided to operate in the two countries, i.e.
0hx > , and 0f fx xθ= > . In addition, the manager is assumed to be able to employ
positive expenditure S to obtain private interest, i.e. 0S > . Therefore, the corner
solution (i.e. * * *( 0, ( ) 0, 0)hx Sθ = = = ) is excluded, i.e. inequalities (4.18), (4.19),
and (4.20) are not binding.
To solve this problem we use the Kuhn-Tucker theorem and formulate the
Lagrangean function as:
1 2 1 0 2( , , , ) ( , , ) ( ) ( )f fL S S R x X x Sθ λ λ β θ θ λ π π λ θ θ= + − + − + − (4.22)
The first order conditions are:
11 0L R
S S S
πβ λ∂ ∂ ∂= + + =
∂ ∂ ∂, (4.23)
1 2 0L R πβ λ λθ θ θ
∂ ∂ ∂= + − =
∂ ∂ ∂ (4.24)
The complementary slackness conditions are:
1 0 1 00, , ( ) 0λ π π λ π π≥ ≥ − = , (4.25)
2 20, 0, ( ) 0λ θ θ λ θ θ≥ − ≥ − = , (4.26)
The solutions of this decision-making problem can be described by four scenarios,
which will be analyzed sequentially.
78
4.4.3 Distortions of investment
4.4.3.1 Scenario 1: ineffective constraints ( * *0 , and π π θ θ> < )
By this, we mean that the constraints are not binding, in other words, the decision
maker’s choice of entry mode is not affected by these two constraints. This scenario
is understandable. When the preset profit 0π is low enough or there is no strict
constraint exerted on the short run performance, and the upper bound of the
ownership ratio interval preset by the board is always high enough, for example it
takes the maximum value of 1, the managers’ decision on investment will then not
be heavily influenced by either of these two constraints. In mathematical terms, from
Kuhn-Tucker theorem, we therefore obtain * *1 2 0λ λ= = .
Replacing * *1 2 0λ λ= = into equations (4.23) and (4.24) one obtains:
1
1 0 0L R R
S S Sβ
β∂ ∂ ∂
= + = ⇒ = − <∂ ∂ ∂
(4.27)
( ) 0( ) ( )
f hf h f
f h
L R q qp p x
x xβ β
θ θ∂ ∂ ∂ ∂
= = − =∂ ∂ ∂ ∂
(4.28)
Eq. (4.27) tells us that in order to maximize his utility, the manager, when facing
no “behavioral constraints”, will try to increase his employment of expenditure to
the point where its contribution to the revenue increment as well as profit is
negative. This is obviously an abuse of the expenditure.
Eq. (4.28) has two implications. Firstly, when facing an unconstrained choice of
investment, the manager tends to invest in the foreign country until the marginal
revenue of investment becomes zero instead of being equal to its marginal cost. That
is to say, he over-invests in the host country in the sense of profit maximization. The
second point is that the manager stops the increment of capital investment in the host
country until the capital investment can bring homogenous returns of revenue in the
two countries. This occurs because the manager has a good incentive to increase the
revenue rather than the profit. This implication is somewhat different with that of
chapter 3, where the manager will stop his increment of investment in the host
country until the profit-earning abilities instead of the revenue earning abilities in
79
the two countries are equal. This arises because we have assumed that the manager’s
discretion during the process of entry mode choice shifts from profit maximization
to revenue maximization, and the managers allocate a portion of the firm’s value to
private interests.
Assuming that the marginal cost curve takes a traditional positive and increasing
slope, Figure 4.1 clarifies this deviation of entry mode choice from profit
maximization explicitly. From this figure, *πθ is the optimal investment level in
terms of profit maximization, *Rθ is the optimal investment level in terms of revenue
maximization. Due to the strict concavity assumption of R in respect to θ and the
fact that the marginal cost of investment is greater than zero, we obtain obviously
that * *R πθ θ> , i.e. the managerial discretion of revenue maximization drives the
manager to select a higher than optimal level of investment in the host country in the
sense of profit maximization. Alternatively speaking, the manager over invests in
the foreign country.
Analogously, we can conclude that *RS , the level of extra expenditure, at which
the revenue is maximized, should be greater than *Sπ , i.e. the level of expenditure at
which the decision maker maximizes the profit. However, the actually employed
level of expenditure, *S , due to the concavity of R in respect to S , and together
with (4.27), should be greater than *RS . In summary, * * *
RS S Sπ> > .
Consequently, we can deduce the first proposition describing this distortion
explicitly.
Proposition 4.2 If the manager faces neither a constraint of minimum profit
nor a constraint of maximum ownership for his investment decision, he will
over-invest in terms of profit maximization in the foreign country to
maximize his pecuniary and non-pecuniary benefits. Meanwhile, due to his
positive preference toward expenditure, he will abuse (i.e. in comparison
with the level of expenditure at which the revenue or profit is maximized) the
controlling instruments, i.e. staff expenditures among others, to earn non-
pecuniary benefits.
80
This proposition is consistent with that of Williamson (1965) and Jensen (2000),
in which the authors found that the separation of management from ownership
induces the existence of agency cost and therefore the distortion of profit
maximization in the output decisions.
Fig. 4.1 Distortion of entry mode choice from profit maximization
4.4.3.2 Semi-effective constraints
By this, we mean that either the preset minimum profit requirement is effective
while the preset maximum ownership ratio being ineffective, or vice versa.
Therefore, we have two scenarios, which will be discussed in turn.
Scenario 2: *0π π> and *θ θ=
This scenario indicates that the decision maker’s choice of market entry is subject
to a strict constraint concerning its maximum ownership ratio imposed by the board,
but no strict constraint exerted for the firm’s profit, at least in the short run.
According to the Kuhn-Tucker theorem, if *0π π> and *θ θ= , we have *
1 0,λ =
and *2 0λ ≥ . Inserting the multipliers into Eq. (4.23) and Eq. (4.24) we obtain:
*
πθ 0
0π
Marginal Cost
R
π
θ *Rθ
*π
*R
81
1
1 0 0L R R
S S Sβ
β∂ ∂ ∂
= + = ⇒ = − <∂ ∂ ∂
(4.29)
*2( ) 0
( ) ( )
( ) ( )
f hf h f
f h
f hf h
f h
L R q qp p x
x x
q qp p
x x
β β λθ θ
∂ ∂ ∂ ∂= = − = ≥
∂ ∂ ∂ ∂
∂ ∂⇒ ≥
∂ ∂
(4.30)
Eq. (4.29) explains that the manager, when facing an effective constraint of the
maximum ownership ratio (i.e. *θ θ= ) but not an effective minimum profit
constraint (i.e. *0π π> ), will over consume his expenditure to the point where its
contribution to revenue increment is negative. To earn extra non-pecuniary benefits
the manager behaves as if the maximum ownership constraint (i.e. *θ θ= ) does not
exist. This is obviously an abuse of expenditure in the sense of profit maximization
as well as revenue maximization.
Eq. (4.30) indicates that due to the effective maximum ownership ratio constraint
(i.e. *θ θ= ) the decision maker’s choice of entry mode may or may not help the
decision maker to achieve revenue maximization. Moreover, the distortion of profit
maximization remains uncertain. If the marginal revenue of capital investment
equals its marginal cost of investment, then there is no distortion of profit
maximization at all.
Conjointly, we develop the third proposition as:
Proposition 4.3 When the manager faces only an effective constraint on the
maximum ownership ratio (i.e. *θ θ= ), he will choose a specific pair of
}{ * *, Sθ , which maximizes his utility of decision-making. The decision
maker’s choice of *S satisfies * * *RS S Sπ> > , which represents an abuse of
expenditure in terms of both profit maximization and revenue maximization.
However the decision maker’s choice of investment *θ does not necessarily
violate the organizational goal of profit maximization or the managerial
discretion of revenue maximization.
82
Scenario 3: *0 ,π π= *θ θ<
This scenario indicates that the decision maker’s choice of market entry is subject
to a strict constraint on the minimum profit level exerted by the board. On the other
hand, his choice is not subject to a restriction of the maximum ownership ratio.
From Kuhn Tucker theorem, we derive that *1 0,λ ≥ and *
2 0λ = . Inserting these two
multipliers into Eq. (4.23) and Eq. (4.24) we obtain:
*11 0
L R
S S S
πβ λ∂ ∂ ∂= + + =
∂ ∂ ∂ (4.31)
*1 0
L R πβ λθ θ θ
∂ ∂ ∂= + =
∂ ∂ ∂ (4.32)
Eq. (4.31) and (4.32) do not explicitly indicate the sign of marginal revenue of
expenditure or that of capital investment. However, due to β being positive and *1λ
being non-negative, we can deduce from (4.31) that
*1
(1 )0
R
S
S
βλ
π
∂− +
∂= ≥∂∂
, which in turn implies either
(1) 0
1 0 0
SR R
S S
π
β
∂ > ∂ ∂ ∂ + ≤ ⇒ ≤ ∂ ∂
or (2)
0
11 0
SR R
S S
π
ββ
∂ < ∂ ∂ ∂ + ≥ ⇒ ≥ −
∂ ∂
. (4.33)
Usually, non-positive marginal revenue does not induce a positive marginal profit
except for a negative marginal cost, which is not the case in our context. Therefore,
(1) describing the conditions, under which the decision maker maximizes his utility
of decision-making, is not feasible. (2) determines the actual level of *S employed
in the process of investment. To maximize his private interest the manager will
increase his employment of expenditure to the point where the marginal profit of
this expenditure becomes negative, and where the marginal revenue is greater or
equal to a negative value. This means that the profit maximization is explicitly
violated and the realization of revenue maximization remains unclear.
From Eq. (4.32), we can deduce that
83
*1
0 0( / ) either (1) or (2)
0 0
R RR π θ θλ β
π πθ θθ θ
∂ ∂ ≥ ≤ ∂ ∂ ∂ ∂= − ⇒ ∂ ∂∂ ∂ < > ∂ ∂
. (4.34)
As analyzed the (1) of (4.34) indicates that the actual investment *θ , at which the
decision maker maximizes his utility of decision-making, brings a non-negative
marginal revenue but a negative marginal profit. This is to say that if the manager’s
utility could be maximized through the choice of entry mode, he will definitely over
invest in the host country, i.e. choose a higher than optimal level of investment in
terms of profit maximization. At this investment level, he may even achieve the
discretional goal of revenue maximization. Therefore, a minimum profit limitation
alone cannot regulate the manager’s over investment behavior effectively, i.e. this is
unable to force him to return to profit maximization. To get an alignment with their
interests of profit maximization, the owners need other monitoring or incentive
mechanisms. The (2) of (4.34) is explicitly not a feasible situation in our context.
In light of this, we conclude with the following proposition:
Proposition 4.4 When his decision on the volume of investment in the host
country is constrained only by a minimum profit ( *0π π= ) set by the board,
the manager will abuse the expenditure violating the profit maximization
(this level of expenditure does not necessarily violate the revenue
maximization) to maximize his utility on the one hand. He over invests in the
host country in terms of profit maximization on the other. At this investment
level, however, the revenue maximization may or may not be violated. This
means that the minimum profit requirement set by the board limits, in a
certain extent, the manager’s discretion of revenue maximization, which
brings him the extreme pecuniary benefits. However, this minimum
requirement is not effective enough to enforce the decision maker back to
profit maximization. Therefore, it requires additional monitoring or incentive
mechanisms to regulate the manager’s investment behavior (Jensen 1986,
2000).
84
4.4.3.3 Scenario 4 effective constraints ( * *0 , π π θ θ= = )
This scenario shows that the decision maker’s choice of entry mode choice is
constrained both by the minimum profit requirement and by the maximum
ownership. Mathematically, we have * *0 , π π θ θ= = , and *
1 0,λ ≥ *2 0λ ≥
consequently. Through some manipulations of (4.23) we obtain:
*1
(1 )0
R
S
S
βλ
π
∂+
∂= − ≥∂∂
. (4.35)
1+ ( / )R Sβ ∂ ∂ is nothing but the manager’s marginal utility of employing one
more unit of expenditure, / Sπ∂ ∂ is the marginal profit of this expenditure. From
(4.35) we can conclude that the manager’s employment of expenditure must bring
him a non negative marginal utility (i.e. (1 ) 0R
Sβ ∂
+ ≥∂
) and a negative marginal
profit (i.e. S
π∂∂
<0) to the firm. This means explicitly an abuse of expenditure.
However, at this expenditure level, whether the revenue maximization is being
violated or not is still ambiguous. This is because the expenditure has two
contributions to the manager, i.e. it brings the manager’s non-pecuniary benefits
directly, and it increases the manager’s pecuniary benefits indirectly through the
increment of revenue.
With *1λ being non-negative and 0 1β< < , (4.24) results either (1)
/ 0
/ 0
R θπ θ
∂ ∂ ≥∂ ∂ ≥
or (2)/ 0
/ 0
R θπ θ
∂ ∂ ≥∂ ∂ <
. (1) indicates that the manager’s choice of investment violates
neither the profit maximization nor the revenue maximization, i.e. the two
constraints are effective enough to regulate the manager’s expenditure preference
and its discretion of revenue increment. (2) indicates however that the manager’s
investment violates the firm’s interest of profit maximization, but leaves the
manager’s discretion of revenue maximization non explicitly violated.
The above analyses lead to the final proposition which reads as:
85
Proposition 4.5 When the manager faces both an effective minimum profit
requirement and an effective maximum investment constraint, he will still
abuse the expenditure to earn non-pecuniary benefits as if the constraints do
not exist at all. However, at this expenditure level the violation of
managerial discretion of revenue maximization is ambiguous. Meanwhile,
whether his choice of investment will violate the organizational goal of profit
maximization or not is ambiguous; for sure is that the managerial discretion
of revenue maximization is not violated. As concluded in Proposition 4.4,
some additional incentive mechanism or regulating instruments are
necessary to be introduced to regulate the expenses preference as well as the
managerial discretion.
4.4.4 Summary
The above discussions on the possible scenarios are depicted in Figure 4.2.
Additionally, the possible distortions of investment due to managerial discretion and
expense preference are summarized in Table 4.1.
With Table 4.1, it is clear that no matter which scenario we find ourselves in, the
expense preference always drives the manager to abuse the expenses to achieve non-
pecuniary benefits; this abuse of expenditure will usually deviate from the
shareholders’ interests of profit maximization. However, our discussion on the
above four scenarios indicates us explicitly that a minimum profit requirement for
the management can regulate the over investment problem significantly, even it
cannot reinforce the manager back to profit maximization completely. In addition,
the conclusions imply the top management in practice that to regulate the managers’
expenditure preference and expansion preference more effectively, additional
measures are necessarily to be adopted rather than the minimum profit requirement
and the maximum ownership ratio only, auditing mechanism and incentive
mechanism are for example.
86
Figure 4.2 The possible solutions to the optimization problem
Table 4.1 The distortions of entry mode choice
Constraints Consumption of expense Distortions of investment
Scenario 1
Ineffective upper bound of ownership
ratio *0( )π π>
Ineffective minimum profit
requirement *( )θ θ<
Over consumption in terms of revenue and profit maximization
Over investment in the sense of profit maximization
Scenario 2
Effective upper bound of ownership
ratio *0( )π π>
Ineffective minimum profit
requirement *( )θ θ=
Over consumption in terms of both revenue maximization and profit maximization
Distortion of profit maximization or revenue maximization remains unclear
Scenario 3
Ineffective upper bound of ownership
ratio *0( )π π=
Effective minimum profit
requirement *( )θ θ<
Over consumption in terms of profit maximization, but unclear with revenue maximization
Over investment in the sense of profit maximization
Scenario 4
Effective upper bound of ownership
ratio *0( )π π=
Effective minimum profit
requirement *( )θ θ=
Over consumption in terms of profit maximization, but unclear with revenue maximization
Distortion of profit maximization remains unclear
S 2
S 3 S 4
S 1
θ * 1θ =
0π
π
87
4.5 Conclusions
As indicated, this model starts with the separation of the ownership from
management, which is a common phenomenon of large firms. Two significant
consequences of this particular organizational structure are identified, i.e. the
specialization, and managerial discretion as well as expense preference. The latter
consequence, i.e. the managerial discretion and expense preference, has actually
been widely discussed in the existing literature (Williamson 1965, Jensen and
Merkling 1976, Jensen 1986, 2000). By applying these two consequences, we have
developed a two-stage model of entry mode choice. The board of directors, on
behalf of the shareholders, makes a strategic choice of entry mode in the first period
by comparing the profitability of each alternative. Taking into account those
decisions made in the first stage, the managers make the investment decisions
tactically to maximize their utility of decision-making in the second stage.
Analyzing the model implies that the board of directors’ choice of entry mode is
influenced by the market structure, firm size, production technology, and the costs
incurred in the process of market entry among others. In the process of
implementing of the strategic decisions made by the board, the managers’ decision
of investment will deviate definitely from the first best result, i.e. profit
maximization, if their behaviors are not constrained. Even if the board sets an
effective minimum profit constraint together with a maximum investment constraint,
it is still not sure that the managers’ investment decision will not deviate from the
first best results. This is just a reflection of the conflicting interests between the
managers and the board of directors, and this is a result of the managerial discretion
and expense preference.
The contributions of this model to entry mode theory lay at least three aspects.
Firstly, it would appear that none of the existing literature has taken the two
consequences (i.e. expense preference and managerial discretion) of the separation
of management from ownership simultaneously in the context of entry mode choice.
Secondly, the two-stage model puts large firms’ entry mode choice in a context
closer to reality. Finally, this way of modeling allows us to investigate explicitly
how the organizational structure influences the choice of entry mode.
88
Our model has been based on the existing agency theory literature, e.g.,
Williamson (1965), Jensen and Merckling (1976, 2000). In comparison with
Williamson (1965), our model has a different structure. In Williamson (1965), the
decision maker decides the optimal quantity of supply through maximizing his
utility, which depends on the firm’s value and an extra expenditure, subject to only a
minimum profit constraint. However, in our model entry mode choice is defined as a
two-stage decision-making problem, in which the manager’s decision on investment
affects not only the expenditure but also the revenue, which bring him non-
pecuniary and pecuniary benefits respectively. The manager’s decision is
constrained not only by a minimum firm value, a preset maximum investment level,
but also by its financial capacity. In some sense, our model can be regarded as an
extension of Williamson (1965).
Jensen and Merkling (1976, 2000) explained mainly how the change of ownership
structure incurs agency cost and influences firms’ optimal expansion paths. In
comparison with Jensen and Merkling (1976, 2000), our model differs from it in at
least fours aspects. Firstly, our model solves firms’ entry mode choice problem with
a consideration of a special governance structure, e.g. ownership from management,
but not a separate ownership structure as that in Jensen and Merkling (1976).
Secondly, in Jensen and Merkling (1976, 2000), the decision maker’s utility is
dependent on the pecuniary and non-pecuniary benefits, which are perfect
substitutes, however, the manager’s utility in our model is dependent on a sum of
pecuniary and non-pecuniary benefits. Thirdly, our analysis of the model is more
algorithmic than graphical. Finally, our model concludes that the separation of
ownership from management, therefore managerial discretion and expenses
preference, induces an abuse of expenditure and an overinvestment. However,
Jensen and Merkling (1976, 2000) concluded that separated ownership structure
shrinks the firm’s optimal expansion path.
Of course, part of our results is consistent with those of the existing literature. The
significant influence of technology and market structure on entry mode choice, the
significant impact of managerial discretion and expense preference on the deviation
of profit maximization, and the necessity of introducing additional monitoring or
89
incentive mechanisms to enforce the managers’ behavior to align with the
organizational interests are for example.
The results offer rich implications for the firms concerned. Firstly, the board of
directors, when they make the entry mode decisions, should consider not only the
objective factors (e.g. market demand and supply, firm size and technology among
others) but also the subjective factors (e.g. the existence of the deviated interests of
the managers and the discretion of decision-making among others). Secondly, to
enforce the manager’s behavior back to shareholders’ interests, some additional
regulating instruments or mechanisms rather than only setting a minimum
performance requirement or a range of choice (i.e. a maximum ownership ratio)
need to be introduced, e.g. auditing, incentive mechanism, and/or a penalty among
others (Laffont and Martimort 2002). Additionally, reducing the managerial
discretion is essentially an efficient way to reduce distortions. The way of modeling
entry mode choice offers new insight as well. By considering the complex
organization structure, the firm’s strategic decisions can be studied in a way, which
is closer to reality.
Future research could be directed to relax some of our strict assumptions (e.g. the
market structure of the host country), which aims to simplify the analysis. Studying
this problem at hand by using the explicit expressions of production technology,
price, and others, deserves consideration. Comparative static analyses to see how the
entry mode choice is influenced by the external parameters quantitatively are
worthwhile examining too. Of course, this problem could be studied under other
contexts, e.g. a principal-agent model or an incentive mechanism. Last but not least,
further empirical studies could be arranged to verify the propositions inferred from
this model.
90
Chapter 5 Organization and Foreign Market Entry Mode Choice
In chapter 4, the large firms’ entry mode choice was analyzed with a special focus
on the influence of the decision maker. Compared with the firm discussed in chapter
3, the firms in chapter 4 have a complex ownership structure and more power in the
market. In such a complex organizational context, consideration of the decision
maker and the internal efficiency are necessary but not sufficient to describe the
entry mode choice in-depth. Technically, a quantitative model itself is insufficient to
explain the strategic decision in such a complex context. Therefore, this chapter
shifts the focus from the individual decision maker and the internal efficiency, to the
complex organization itself and its fitness within the surrounding environment
through applying a qualitative analysis.
This chapter is structured as follows. Section 5.1 introduces the relevant literature,
e.g. the organization capability model considered by Madhok (1996, 1997), which
focuses on the analysis of the organization in the context of market entry. Section
5.2 studies how other organizational characteristics rather than the organizational
capability could influence entry mode choice. As well, propositions are developed to
describe the directional relationships to entry mode choice. This chapter closes with
some implications as well as guidelines for future research.
5.1 Review of the literature
Most of the existing literature that concerns the organizational aspects during the
process of entry mode choice aimed at identifying the possible influences of some
organizational characteristics on entry mode choice in distinct contexts. The most
frequently discussed organizational characteristics are firm size (Erramilli and Rao
1993, Reuber and Fisher 1997, Evans 2002, Leung et al. 2003), organizational
experience (Evans 2002, Brouthers 2002, Herrman and Datta 2002, King and Tucci
2002), and organizational culture (Cristina and Esteban 2002, Leung et al. 2003).
91
The inferred relationships between these organizational characteristics and entry
mode choice can conflict with each other. The possible relationships identified are
positive, negative, or irrelevant. For an extensive discussion, see chapter 2.
Within the literature, which studied entry mode choice by taking the organization
as the core of analysis, Madhok’s (1996 and 1997) organizational capability (OC)
theory is worth explaining in more detail.
5.1.1 The OC theory
Madhok (1996 and 1997) developed the OC theory to explain the firms’ boundary
issues. The OC theory motivates itself by the inadequateness and incompleteness of
both the TC theory and the internalization theory in explaining firms’ boundary
decisions. Furthermore, this theory bases itself on the well-known resource-based
(RB) theory (Penrose 1959, Conn er 1991, Prahald and Conner 1996) and the
knowledge-based theory of the firm (Kogut and Zander 1993), in which the firm is a
collection of productive resources, both physical and human oriented, which are
organized by the administration.
The firm, in the OC theory, is defined alternatively as a bundle of knowledge and
the underlying process therein (Madhok 1997). The firm is a rent seeker, i.e. it is
rational in rent maximizing. The firm’s economic activities are assumed to be flows
of know-how or know-how related resources. Therefore, an exploitation and
exploration of a firm’s organizational capability in maximum is the goal and
criterion of the boundary decisions. In the context of Madhok (1996 and 1997), the
organizational capabilities, as the “precursor” Richardson (1972, p.888) defined
implicitly, are the knowledge, experience, and skills of the firm. This definition is
reflected by the relevant OC attributes later developed in Madhok (1998).
This definition of the firm as well as its application for firm’s boundary decisions
are compared with the TC theory and the internalization theory in the following.
On comparison with the TC theory and the internalization theory
It appears that Madhok believes although being not a completely new theory of
firm, the OC theory does step forward on a firm’s governance or boundary analysis
92
by its increased completeness, adequateness and being more realistic in comparison
with the TC theory or the internalization theory (Madhok 1996 and 1997).
The OC theory differs or advances the TC theory and the internalization theory in
explaining the corporate governance or boundary issues in the following aspects:
1. it is less restrictive in its assumptions. Unlike the restrictive assumptions of
the TC theory or the internalization theory on asset specificity, opportunism,
and bounded rationality, the OC theory assumes only bounded rationality,
2. it shifts the unit of analysis from the transaction and transaction
characteristics to the firm itself and its capabilities. The corporate
governance is treated as a tradeoff between the exploration and exploitation
of firm capabilities. This methodology is different from that of the TC
theory, in which the corporate governance is solved as a cost efficiency
problem,
3. it incorporates the managing of value (i.e. the generic value as well as the
embodied value, or the value and its supporting structure), both in erosion
and in enhancement, into corporate governance or boundary analysis.
Meanwhile, it does not deny the efficiency of costs. As summarized by
Madhok (1997, p.56): “the corporate governance decision should be made
on basis of tradeoffs: between value and costs considerations, between
ownership and location effects, between capability exploitation and
development, between TC and capability-related considerations”.
5.1.2 Applications to entry mode choice
The OC theory indicates that corporate governance or a firm boundary issue
depends on the net benefit of internalizing a transaction within a firm. The net
benefit is the gross benefit of internalizing a transaction deducted by the relevant
costs. The gross benefit is the sum of the value added and the costs avoided through
internalizing a transaction within the firm. The cost of internalizing a transaction is
the sum of the internal governance costs and the internal costs associated with firm
capacities (i.e. the difference between internal production costs and external
production costs).
93
The internalization of a transaction is taken as a process of resource transfer or
knowledge transfer in the context of the OC theory. Motivated by this concept,
Madhok (1997) developed some propositions predicting the choice of entry mode.
The entry mode choice is dependent on the property of firm-embodied knowledge,
whether it is more ownership specific (i.e. face high potential loss in transferring to
another firm), or more location specific (i.e. face high potential loss in transferring
to other country). If the firm-embodied knowledge is more ownership specific, then
a subsidiary is preferred; otherwise, collaboration is preferred. When the firm-
embodied knowledge is both ownership specific and location specific, the efficient
entry mode is dependent on which specificity is stronger. In addition, the OC theory
predicts that in a dynamic environment, collaboration will be more preferred when
the operation is motivated by future value exploration orientation. The underlying
assumption is that collaboration is helpful to develop a future capability base
(Madhook 1997, p.51).
Madhok (1998) empirically shows that the OC attributes are more relevant than
the TC attributes or the internalization attributes in explaining entry mode choice.
The OC attributes are mainly a firm’s historical experience as well as the cultural
distance.
The OC theory is more in tune with today’s dynamic and competitive
environment in explaining entry mode choice. Because it focuses more on value
exploitation and exploration, and therefore the competitive advantage for the
corporate governance decisions, and it is more consistent with the current firms’
behaviors as suggested in chapter 4.
However, the OC theory has also some limitations in explaining entry mode
choice, which have been summarized in chapter 2.
5.1.3 The implications for entry mode study
The existing empirical studies on the influence of organizational characteristics on
entry mode choice have exhibited great inconsistencies. These inconsistencies, as
analyzed in chapter 2, could arise from the different methods applied, the different
samples used, the different expectations on the side of analysts, or the different
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analysis contexts. The directional effects of organizational characteristics on entry
mode choice are greatly dependent on the special context of decision-making.
Complementing the long run competitive capability with the short run
organizational efficiency as a goal and criterion of organizational entry mode choice
will be more complete in theory, and yields better measurability in practice. This is
to take the concept of organizational performance as a goal and criterion of entry
mode choice (Evan 1993). Alternatively, both the costs and the benefits should be
considered equally during the process of strategic decision-making (Brent 1997).
Accepting that organizational capability is a long-run goal and criterion of entry
mode choice, other sources of organizational capabilities need to be identified. As
suggested by Porter (1985), organizational strategy, cost reduction, technology and
product differentiation, market focus, and competition are all possible sources of
organizational capacities.
The OC theory is more normative rather than descriptive. This theory has very
limited explanatory power in explaining how the entry mode choice should actually
proceed.
5.2 Organizational attributes and entry mode choice
5.2.1 Organizational performance, value system, and market entry
A large section of the literature has been devoted to the study of the relationship
between a firm’s degree of internationalization and performance. The representative
relationships concluded were a trigonometric wave by Sullivan (1994), a converted
“U” shaped by Hitt et al. (1997), a converted “J” shaped by Gomes and Ramaswamy
(1999), and a standard “U” by Ruigrok and Wagner (2003). Despite the variety of
shapes, the existing studies show strongly that there is a correlation between a firm’s
performance and internationalization.
The organizational performance (OP) covers two aspects, namely the long run
organizational competence and the short run economic efficiency. The
organizational effectiveness (OE) is the most widely applied measure of the OP, and
it serves also as a good substitute. Actually, organizational scientists do not
95
differentiate the OP from the OE explicitly (Robbins 1983, Evan 1993). The OE is
an important criterion of behavior (Tourinho and Neno 2003). However,
organizational scientists do not usually agree with each other on how the OE should
be measured, i.e. what essentially determine the OE (Robbins 1983, Evan 1993).
Evan (1976 and 1993) suggested a systematic methodology of evaluating the OE.
By this method, he defined the OE as a capability of an organization to cope with all
four systematic processes (i.e. inputs, transformation, outputs, and feedbacks)
relative to goal seeking behavior, no matter how explicit or implicit this may be. He
also developed nine ratios as the objective measures of the OE (Evan 1993, p.377).
This systematic method originates, at least partially, from the concept of value chain
and value system by Porter (1985), where the author suggested that organizational
competitive advantages depend not only on the firm specific value chain activities
but also on the value system, of which the firm is a part.
The value chain activities include the primary activities creating the value directly
(i.e. the inbound logistics, operation, outbound logistics, marketing and sales, and
service), and the supportive activities (i.e. the procurement, technology
development, human resource management, and firm infrastructure). The value
system is an expanded value chain including the firm’s upstream supplier and the
downstream buyer (Porter 1985).
The existing literature has widely recognized that the inefficiency of value chain
activity thereby the instability of the value system asks for an adjustment of firms’
strategies, e.g. market entry. Kogut (1984) illustrated that the global strategies
succeed by creating certain economies along and between value-added chains. Li
and Whalley (2002) have shown that a change of value chain asks for a reevaluation
of firms’ strategies. Mol et al. (2005) argued that the instability of the value system
(i.e. arising due to the existence of a value chain envy, which is a result of the
difference between the value created and value captured by a certain value chain
activity) induces a new entry or a merger and acquisition. They empirically
supported the following argument:
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“Instability of the value system will lead to value chain envy and will
consequently elicit strategic responses by other actors, who will try to occupy the
more desirable stages by engaging in new entry or vertical integration”.
A big literature has found that an instable environment (political, institutional, or
market-oriented) leads to a high equity entry mode. Rasheed (2001) empirically
found that the more instable the environment is, a higher equity mode of entry is
required to remain efficient. Meyer (2001) argued that an instable institution of entry
mode choice induces a high level of equity mode. Nieminen et al. (2001), through a
survey on 139 Finish and 97 Austrian companies, found that high-commitment
modes were frequently used in the markets that contain more instability. Similarly,
Shenkar and Luo (2003) argued that the more unstable the market structure, the
more complex the project, then the more likely that the entry mode will be a foreign
direct investment, i.e. the higher equity entry mode is adopted. Analogously, we can
infer the first proposition describing the influence of the instability of value system,
i.e. this instability may arise from the inefficiency of value chain activities, on entry
mode choice.
Proposition 5.1: The more unstable the value system (i.e. the instability may arise
from the inefficiency of value chain activities) is, the higher the equity mode of entry
requested.
Recognizing the fact that the inefficiency of value chain activities, and therefore
the instability of value system, call for an adjustment of firms’ strategic decisions,
this proposition, as far as the existing literature concerned, firstly analyzes the firm’s
boundary issue in a value system context. A directional relationship between the
inefficiency of value chain activities and entry mode choice is proposed explicitly. A
good example is that in practice many firms integrate the supply chain activities
vertically to increase the efficiency of supply, i.e. to reduce the high cost, to control
the quality, and to ensure the stability of supply (Nissen 2001).
5.2.2 Organizational philosophy
As analyzed above, the corporate strategy is one of the important sources of
competitive advantage. The organizational behaviors are the results of
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organizational philosophy and thereby the organizational strategy (Mawhinney
1984, Bucklin et al. 2000). Therefore, the organizational philosophy is an important
attribute that influences the organizational behavior. Unfortunately, there is very
little literature identifying its influence on entry mode choice explicitly.
However, there is a big literature indicating that the firm’s global strategy has an
influence on entry mode choice. Based on the TC theory, Hill et al. (1990)
established an eclectic framework to explain entry mode choice. They integrated the
strategic factors and the environmental factors into their analytic framework.
However, the global strategies, in their framework, are differentiated into three
branches, namely the multi-domestic strategy, the global strategy, and the global
coordination strategy. Under the multi-domestic strategy, as they argued, the global
firm needs to set up all functions (e.g. marketing, production, distribution and so on)
in every country to adapt to different market environments. Therefore, a low degree
of control is required. Under the global strategy, they claimed that the global firm
disperses various functions, e.g. production, distribution and sales, into different
countries, a high level of control is necessary to coordinate all the functions
efficiently. The global coordination strategy exists in a duopoly context where the
players enter into a market only for coordinating, the mode of entry is not dependent
on a calculable profit but on the firm’s overall value. Therefore, a high level of
control is required for this consideration.
Some other economists analyzed global strategic factors from different angles
within a similar framework. Kim and Hwang (1992) analyzed the influence of
global strategy on entry mode choice with the framework of Hill et al. (1990). Put
differently, global concentration, global synergies, and global strategic motivation
are three global strategic considerations in the context. Alternatively, Aulakh and
Kotabe (1997) analyzed the influence of global strategy together with the other two
aspects, namely transaction cost and organizational capability, on channel
integration. The global strategy was studied from the perspectives of the global
market position, the overall cooperative objectives and the differentiation strategy.
Of course, there are some other economists, who have studied this problem from a
different perspective (Kogut 1988, Klein et al.1990).
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Obviously, all these studies reinforce the concept that entry mode choice is
influenced by a firm’s global strategy. However, the firm’s other strategies might be
more influential on entry mode choice in a new context. For example, it is difficult
to imagine that a firm with a strategy of transforming itself to retailing industry will
invest for production in a foreign country.
Behavior economists as well as organizational scientists argued that
organizational behavior is influenced by organizational philosophy and thereby the
corporate strategy (Simon 1957, Mawhinney 1984, Pennings 1986, Cyert and March
1992, and Bucklin et al. 2000). It is hard to imagine that a firm with a philosophy of
doing things their own way will invest via a JV with its partner being in the
majority. Additionally, Purcell and Stephen (2000) have identified that the
organizational philosophy is a critical factor influencing Japanese tourism firms’
choice of entry mode in Australia. Therefore, we recognize the influence of
organizational philosophy and thereby the corporate strategy on entry mode choice
as follows:
Proposition 5.2 The choice of entry mode is influenced by the firms’
corporate strategies, which are shaped by its philosophy of what and how
things should be carried out. Firms with a philosophy of doing things their
own way will adopt a WOFV rather than a JV for their foreign investment.
5.2.3 Organizational experience
Cost reduction is another important source of competitive advantage. Cost
reduction is a result of organizational learning, i.e. organizational experience
(Robbins 1983, Bruton et al. 1994). However, the influence of organizational
experience on entry mode choice, as indicated in chapter 2, is quite controversial.
Additionally, there are different versions of explanations on this phenomenon, which
will be discussed in the following sub-section.
Two schools explaining the conflictions
The influence of the organizational experience on a firm’s strategic decisions, e.g.
globalization, is quite controversial in the theories and the empirical studies. There
are mainly two schools, which explained the influences of organizational experience
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on organizational internationalization differently. One is the “humanity” theory of
the firm (Stopford and Wells 1972), the other is the “ethnocentrism” theory of the
firm (Wiechmann and Pringle 1979).
The incremental or gradual process theory of a firm’s internationalization
originated from Johanson and Wiedersheim-Paul (1975), Johanson and Vahlne
(1977, 1992), and Coviello and Munro (1997) can be explained via the “humanity”
theory of the firm. This “humanity” theory postulates that successful experience in
foreign market increases the confidence of further investment. Therefore, firms will
increase their resource commitment with the increase of experience in the foreign
market.
However, this “humanity” explanation on a firm’s internationalization is
challenged by the “ethnocentrism” theory of the firm. This “ethnocentrism” theory
argues that a firm prefers to make things done in its own way at first; because they
believe that by doing so, they can exploit their competitive advantages more
effectively. Being more familiar to the local people, values and/or cultures, the firm
may loose its control whenever the exploitation of its competitive advantages is not
threatened (Wiechmann and Pringle 1979).
As discussed in chapter 2, these two schools have been applied to explain the
choice of entry mode and both find empirical supports. Figure 5.1 depicts these two
controversial schools explaining the influence of organizational experience on entry
mode choice in one diagram.
Explicitly, these two schools have both explained the choice of entry mode from
the perspective of the traditional learning curve effect (Bruton et al. 1994, Hitt et al.
1997). They are two ways of viewing one issue. Both have shown the evolution of
equity involvement with the increasing experience accumulated in the foreign
market. The difference arises from the distinct assumptions on the philosophy of
doing business. The manager in the “humanity” theory of the firm prefers to adopt a
low equity mode when he has low experience; however, the manager in the
“ethnocentrism” theory of the firm reacts differently. Both explanations predict a
unilateral effect of experience on the equity involvement in their entry mode
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choices, either positive or negative. Both assumptions are reasonable and exist in
reality.
Figure 5.1 The “Humanity” and “Ethnocentrism” theory of the firm
A “U” shaped relationship between organizational experience and performance
There is a considerable volume of published literature, which has studied the
influence of the organizational experience on a firm’s performance. These studies
found that the organizational learning accompanies the process of a firm’s
internationalization, which influences thereby the firm’s performance (Haleblian and
Finkelstein 1999, Ruigrok and Wagner 2003).
In terms of the predicted directional relationship between the organizational
experience and the performance, many researchers supported a “U” shaped
relationship (e.g. Haleblian and Finkelstein 1999, Ruigrok and Wagner 2003).
Ruigrok and Wagner (2003) argued that the process of internationalization incurs
both costs and benefits. If one considered only the costs of the internationalization,
he leads to the traditional learning curve result; however, when one considers both
the costs and the benefits of the internationalization, he leads to the “U” shape. In
detail, when a firm internationalizes its business in a culturally similar country, the
internationalization brings a high performance through the benefits of the economies
of scale. In this regard, the organizational experience is positively related to
performance. However, if a firm started to internationalize in a culturally distinct
Equity level of entry mode
Experience
“Humanity” theory
“Ethnocentrism” theory
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country, the internationalization incurs a high cost of reconfiguring itself to adapt to
the distinct environment. This high cost of reconfiguring results in a low
performance; in this sense, the organizational experience contributes negatively to
performance. Passing a threshold, where the benefits obtained from its
internationalization equate the costs of the reconfiguration, the firm starts to earn a
net benefit from the reconfiguration, i.e. the experience contributes positively to the
performance again.
Haleblian and Finkelstein (1999), however, explained this “U” shaped
relationship with a behavioral learning theory. This theory is motivated through the
distinct influences of the “antecedent” and the “consequence” on a current decision-
making. The “antecedent” refers to the present environment, and the “consequence”
refers to the past. Under this theory, the prior experiences differentiate, from the
perspective of their relevance to current decision context, into two categories:
similar experience and dissimilar experience. The decision maker is named a novice
when he has very little experience, and an expert later when he has accumulated
very rich experience. The decision maker takes different actions on the experience of
globalization, either generalization or discrimination. The novice has a high
frequency of applying prior experience inappropriately for current decisions through
generalizing a dissimilar experience or misinterpreting a similar one. Therefore, the
experience shows a negative relationship with performance at first. With more
experience accumulated, the novice becomes an expert, he makes fewer mistakes in
applying the prior experience for current decisions, and therefore the performance
improves with the experience accumulated. The above-described process results a
standard “U” shaped relationship.
These two ways of explaining the “U” shaped relationship differ from each other;
however, they are essentially not contradictory. The directional relationship between
the organizational experience and performance depends essentially on the difference
of the costs and the benefits, which are the results of applying prior experience for
current decision-making. These two methods imply an alternative way of
understanding the influence of organizational experience on entry mode choice
rather than the time frame explanation of Erramilli (1991).
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A “U” shape between organizational experience and entry mode choice
The process of a firm’s internationalization incurs both benefits and costs. In
terms of the organizational experience, an appropriate application of prior
experience during the process of internationalization brings the firm benefits through
economies of scale. However, reconfiguring or an inappropriate application of the
prior experience for the current entry mode choice may also bring with it high costs.
When the benefits cannot cover the corresponding costs, the firm will decrease its
level of resource commitment in the foreign market, i.e. the entry mode choice is
negatively related with the prior experience, and vice versa. Therefore, we conclude
the last proposition describing the influence of the organizational experience on
entry mode choice.
Proposition 5.3 The organizational experience has a “U” shaped relationship
with entry mode choice. The directional relationship between entry mode choice and
the organizational experience depends on the comparison of the benefits with the
costs, which are the results of applying the prior organizational experience for the
present decision. When the benefits cover the costs, the organizational experience
will increase the firm’s resource commitment in the foreign country, i.e. a high
equity entry mode is adopted, and vice versa.
5.3 Conclusion
This chapter, as a part of our systematic model, has focused on how the
organization itself as well as its external environment influences the entry mode
choice. Based on the weaknesses of the OC theory in explaining the entry mode
choice as well as on the conflicting results in the theoretical and the empirical
studies, this chapter has proposed the predictive influences of some organizational
characteristics on entry mode choice.
Above all, the organizational characteristics, i.e. organizational philosophy and
organizational experience, are assumed to be critical, and they were discussed in
details. The managers in practice are well advised, according to the concluded
propositions, that choice of entry mode should be consistent with the existing
corporate philosophy, alternatives which conflicts with the corporate philosophy will
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not be adopted in the end. If the firm has relevant experience obtained from other
markets, due to the fact that applying this experience for the current market might
incur a huge transferring cost, a low equity entry mode is suggested. However, if the
firm has prior experience obtained directly from this market, a high equity entry
mode could be considered. Of course, experience is not the only thing to be
considered in the process of decision-making.
The interesting proposition concluded through a qualitative analysis is that the
instability of the value system, i.e. the inter-organization system, pushes the firm to
integrate horizontally or vertically in order to achieve stability and thereby
efficiency. This conceptual analysis gives modeling entry mode choice with a focus
on the inter-organizational relationships quantitatively a good indication.
Additionally, these findings inspire an empirical research to investigate their
validities, which will be implemented in chapter 7.
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Chapter 6 Syntheses of the Systematic Analyses on Entry
Mode Choice
In the previous chapters, entry mode choice was analyzed through applying a
systematic methodology with a longitude consideration. This chapter aims to
summarize the results concluded in previous chapters in order to conceptualize the
systematic framework of entry mode choice.
Therefore, this chapter is structured as follows. Section 6.1 summarizes all the
propositions developed in previous chapters. Section 6.2 conceptualizes the
systematic framework of entry mode choice.
6.1 Summary of the propositions
Totally 14 propositions, as summarized in Table 6.1, were developed to predict
the influences of each system component on entry mode choice in this dissertation.
Propositions 3.2 to 3.4(c) explain how the environment influences entry mode
choice. Proposition 3.1 however indicates the influence of the manager’s risk
aversion on entry mode choice. Propositions 4.1 to 4.5 illustrate the influence of the
decision makers on entry mode choice. Explicitly, propositions 5.1 to 5.3 imply how
the organization might affect entry mode choice.
These propositions present an outline of a systematic approach and indicate to the
manager in practice what kind of factors should be considered during the process of
entry mode decision and how they might influence their decisions.
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Table 6.1 Propositions review
Components Attributes Proposition
No. Brief description
Risk aversion 3.1 Negatively related to entry mode choice
Decision maker
Managerial discretion and expenses preference
4.1-4.5
Board of directors choose entry mode strategically. Managers’ expenses preference induces an abuse of expenditure and thereby over investment. Managerial discretion of revenue maximization also leads to over investment, and distorts the profit maximization. A minimum profit constraint and an ownership constraint cannot ensure a first best result of investment. Both constraints cannot prevent the abuse of expenditure effectively as well.
Organizational performance (organizational effectiveness)
5.1
The more instable the value system (i.e. instability arising from the inefficiency of value chain activities) is, the higher the level of control (i.e. equity mode of entry) is requested.
Organizational philosophy
5.2
Organizational philosophy influences choice of entry mode, a firm with a philosophy of doing things their own way will invest via a WOFV rather than a JV, or a JV in the majority rather than in minority.
Organization
Organizational experience
5.3 A “U” shaped relationship between the organizational experience and the equity level of entry mode
Estimated risk in the host country
3.2 Negatively related to entry mode choice
Profitability in host country
3.3 Positively related to entry mode choice
Attractiveness of host country market
3.4 (a) Positively related to entry mode choice
Capital cost rate in host country
3.4 (b) Negatively related in a certain interval
Environment
Tax rate in host country
3.4 (c) Negatively related in a certain interval
6.2 A conceptually systematic framework of entry mode choice
6.2.1 Exploring the determinants of entry mode choice
As summarized in Table 6.1, the factors to be considered during the process of
entry mode choice can be explored from each systematic component respectively,
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namely the decision maker, the organization and the environment. Root (1987, p.9)
explored, however, the influential factors from a perspective of the organizational
boundary, i.e. the internal and the external organization. Referring to this
organizational boundary idea, we suggest a thorough evaluation on the relevant
factors by employing a systematic approach during the process of entry mode
choice. Figure 6.1 presents this systematic approach, which is, of course, rather
heuristic than algorithmic, by this we mean that the factors to be considered are not
limited to what have been studied and displayed.
Figure 6.1 Factors influencing entry mode choice
This framework puts a firm’s strategic decisions, e.g. entry mode choice, into a
systematic context. More importantly, this framework suggests an alternative way of
exploring the determinants of entry mode choice. Following this systematic analysis
rather than the OLI framework, the OC framework, the TCA framework, or intuitive
judgment, the decision maker will make fewer mistakes in ignoring important
Home country factors - market attractiveness 1) market size 2) production cost 3) policy regulation 4) perceived risk
Host country factors - market attractiveness
1) market size 2) cost advantage 3) tax rate 4) perceived risk
Organization 1) performance/effectiv
eness 2) philosophy/strategy 3) experience 4) size
Decision maker 1) risk aversion 2) managerial
discretion 3) expense preference 4) background 5) characteristics
Entry mode
choice
EXTERNAL
INTERNAL
ORGANIZATION DECISION MAKER
ENVIRONMENT
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factors in the process of entry mode decision. Additionally, recognizing that the
entry mode choice is a conjoint art of the decision maker, the organization, the
environment, and their interactions, the decision maker will less likely over
emphasize the impact of one or two aspects by underestimating other aspects.
6.2.2 Formulating the process of entry mode choice
The above subsection has suggested to the manager in practice how to explore the
important factors in face of entry mode decisions. However, the question that
remains unclear is that how entry mode decisions should be made in procedure?
Integrating the organizational factors discussed in chapter 5, the decision makers
related considerations in chapter 4, and the environment related factors in chapter 3
Figure 6.2 describes a new process-oriented model of entry mode choice. This
process-oriented model complements the content-oriented analyses in previous
chapters.
This model, as described in Figure 6.2, consists of five stages. Firstly, evaluate the
organizational performance. As suggested by Proposition 5.1, the organizational
performance provides not only the condition but also the constraint to entry mode
decision. As analyzed above, the instability of value system arouses usually vertical
integrations (Mol et al. 2005). Additionally, to realize the economic efficiency firms
usually integrate horizontally to exploit their competitive advantages in depth
(Porter 1985, Müller 2001). Therefore, diagnosing the organizational performance
indicates not only the necessity of new market entry but also a narrower scope (i.e.
in comparison with Root (1987) and Young et al. (1989)) of entry modes to be
considered.
The second step is to check the contingent environment of entry mode choice, e.g.
market size, tax rates, tariff, host country government policy, and technology, which
were identified to be influential on entry mode choice by Proposition 3.2, 3.3, 3.4,
and 4.1. Through this, we can reject those entry modes that are explicitly not fit for
the environment.
The following step is to check the remaining entry modes within the
organizational philosophy, the organizational strategies as well as the organizational
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objectives, which corresponds to Proposition 5.2. This step together with the
previous step will result in a feasible set of entry modes.
To identify the optimal entry mode, we need further to compare the costs, the
benefits, and the potential risks of each alternative. However, as indicated in the
previous chapters, this cost-benefit-risk analysis leads to an at most near-optimal
decision if the manager’s risk aversion and the managerial discretion were not
absent during the process of entry mode choice (as implied by Proposition 3.1, 4.2,
4.3, 4.4, and 4.5). According to the conclusion that, when there is not an effective
monitoring mechanism, the decision makers usually over invest in the host country
and hence a corresponding adjustment on the near-optimal entry mode is therefore
indispensable to obtain an optimal entry mode.
To express this systematic logic explicitly, Figure 6.2 employs different colors.
The blue part concerns the environmental considerations, the green part relates to
the decision makers related considerations, and the red part refers to the
organizational considerations. Additionally, “P” is the abbreviation of “proposition”.
Following this systematic model the managers in practice will reduce the risk of
ignoring some important factors in the process of entry mode decision, will save the
time and cost for entry mode decision-making, and will also increase the probability
of a right entry mode decision being made in the end. In particular, a careful
evaluation on the surrounding environment will provide the decision maker a clear
picture of the existing conditions as well as constraints of entering into a new
market. The consideration of the organization itself will ensure that the choice of
entry mode is consistent with the company’s strategy, philosophy, etc. This
consistency guarantees a sustainable development of the firm. Last but not least, an
adjustment on the managerial discretion and the risk aversion will reduce the agency
cost significantly in the process of entry mode choice; this ensures that the resulted
entry mode deviates not so far from the organizational goal of profit maximization.
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Figure 6.2 Procedures of entry mode choice
P 5.1: evaluate organizational performance:
Conditions & constraints of entry mode choice
Stability of Value system
Efficiency of value chain activities
Supplier
Supportive activities
Primary activities
Purchasers
Vertical integrations
Horizontal integrations
Necessity of market entry, a narrow scope of modes
P5.2: Check organizational philosophy, organizational
strategies, and organizational objectives
All feasible entry modes
P4.1: Evaluate the costs, benefits, and risks of each feasible mode
Near-“optimal” mode
Rejected entry modes
P 3.2, 3.3, 3.4, 4.1: Check the external environment: market
structure, technology, government policy, tax, and tariff
Rejected entry modes
P 3.1, 4.2-4.5: evaluate manager’s
risk aversion, managerial
discretion and expense preference
Adjust the near-optimal mode accordingly
The “optimal” mode
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6.2.3 Why model entry mode choice separately
Figure 6.2 displays the systematic framework. This framework consists of three
sub-models, which were developed in chapter 3, 4, and 5 respectively. One reason
for modeling a firm’s entry mode choice separately and in different contexts is that,
firms in different size categories may have different resource capacities and
organizational structures. Therefore, they may face distinct conditions as well as
constraints for their entry mode choices, i.e. distinct contexts of decision-making.
The other reason is the difficulty of analyzing these three parts simultaneously in a
general framework without foregoing many insights.
Actually, these three sub-models not only aim at different sized firms but also
emphasize, in particular, different systematic components respectively. For example,
the prototype model in chapter 3 aims at the SMEs, which are characterized by an
alignment of the ownership and the management. Under the assumption of such a
simple organizational structure, the model emphasizes therefore particularly on the
influence of the surrounding environment on entry mode choice. However, the
model in chapter 4 aims at large firms, which are characterized by a separation of
ownership from management, and emphasizes particularly on the influence of
specialization, managerial discretion, and expenses preference (i.e., which are the
results of this particular corporate structure) on entry mode choice. Finally, the
organizational analysis in chapter 5 complements chapter 4 with a focus on the
organization’s external fitness with the environment as well as the organization
itself.
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Chapter 7 Market Entry Mode Choice: German Firms in
China
This chapter aims to verify empirically the deterministic relationships between the
systematic components and entry mode choice, which are proposed in previous
chapters. Despite this, the factors influencing the firms’ market choice will also be
exploited in depth.
This chapter is structured as follows. Section 7.1 explains why German firms have
focused on China as their FDI destination. Section 7.2 describes the sample, the data
upon which the analysis is based, and the methodology applied. Results of analyses
together with the comparison with previous findings are given in section 7.3.
Finally, this chapter concludes with some implications for the decision maker in
practice as well as an outlook for future research.
7.1 Why study German firm’s investment behavior in China?
7.1.1 China as an emerging market
With its sustaining high rate of economic growth and political stability, China has
become an important emerging market among others like Eastern Europe, Brazil,
and Indian. However, China distinguishes itself from the others by its high market
potential, low labor cost, and ample business opportunities.
According to Trinh (2004), a report of Deutsche Bank, China is estimated to have
around 76 million prosperous consumers in 2001, less than the 236 million of
American, and the 110 million of Japan, however more than the 70 million of
Germany. However, in 2015, as estimated, China will have 700 million prosperous
consumers. This figure significantly surpasses the estimated 284 million prosperous
consumers of America.
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According to the World Investment Prospects 2004 (a survey of 500 global senior
executives to explore the corporate expectations for FDI) of the Economist
Intelligence Unit, China is viewed as the top emerging market for FDI. A US$ 80
billion FDI is forecasted to flow into China in the year 2008. The relative strengths
and weaknesses of the potential FDI destination countries and regions are reported
in Table 7.1.
Table 7.1 Analysis on key FDI destination countries
China Euro
area
Japan Russia USA India New EU
entrant
Brazil
New consumer
market
49 9 2 5 7 9 15 4
Low cost labor 50 2 0 3 1 29 12 3
New partnership
possibilities
20 22 5 5 14 12 14 3
New corporate
market
23 22 3 5 17 7 15 4
Access to highly
skilled labor force
6 22 7 3 14 30 10 2
New opportunities in
outsourcing
16 9 1 3 7 46 12 4
Acquisition
opportunities
15 20 2 5 13 8 22 9
Research and
development activity
11 20 5 4 22 24 6 3
Great efficiencies in
supply chain
17 26 6 2 22 10 9 3
Source: World Investment Prospects: The revivals of globalization (page 11), Economist Intelligence Unit 2004
7.1.2 FDI in China
China has become the second biggest FDI destination country in the world, and its
economic growth benefits from this increasing FDI inflow (Kerr and Peter 2001,
Pan 2003, Wei et al. 2004). The total FDI inflow in 2004 amounts to US$ 60.63
billion, which exceeded the expected value of US$ 58 billion (e.g. Trinh 2004,
World investment prospects 2004). This makes the estimated US$ 80 billion of FDI
113
inflow to China in 2008 reasonable. Additionally, China has increased its FDI
inflows in recent years. Figure 7.1 shows this trend explicitly.
Figure 7.1 FDI inflow to China (1999-2004)
43,6442,17
64,19
42,09
71,13
48,82
84,75
55,01
115,06
53,51
153,48
60,63
0,00
20,00
40,00
60,00
80,00
100,00
120,00
140,00
160,00
US$ billion
1999 2000 2001 2002 2003 2004
Year
FDI inflow to China
Contract
Actual
Data source: The Ministry of Commerce of the People’s Republic of China.
7.1.3 German investment in China
Germany has become an important trade partner of China since the 1990s,
meanwhile it was the seventh biggest FDI source country of China in 2003. The
German investment in China has increased from Euro 800 million in 1995 to an
estimated Euro 7.9 billion in 2003 (Trinh 2004). A steady growth of German FDI in
China is shown in Figure 7.2.
However, this estimated Euro 7.9 billion investment in China consists only 1.2%
of the total value of German FDI. The bulk German investment still goes to the EU
or America, each attracting about 40%. This allocation is presented in Figure 7.3.
What is surprising is that Trinh (2004) forecasted a prospect of Euro 18-20 billion
of German investment in China in next six years, until 2010. This inference is based
on a survey of 23 top German firms listed in the DAX 30.
114
Trinh (2004) described the origin and destination of German investors in China in
Figure 7.4 and Figure 7.5. Clearly, automotive, machinery (i.e. electronic machinery
included) and chemistry are three main industries of German investment in China.
Undoubtedly, China will become one of the most important FDI destination
countries for German firms. The recent treaties signed during German chancellor
Schroeder’s visit to China in 2003, promoting and protecting German investment in
China, strengthen this trend. Therefore, it is clearly necessary to study how German
firms make their entry mode decisions, and how should they make such decisions in
order to ensure successful entries into the market.
Figure 7.2 German investment in China (1995-2003) Figure 7.3 Overall German investment distribution
Figure 7.4 Origin of German Investment Figure 7.5 Destination of German investment
Sources: Trinh (2004), “Foreign direct investment in China-good prospects for German companies?
China special”, Deutsche Bank Research, Aug 24, 2004, 1-11.
115
7.2 Data and methodology
7.2.1 The sample
The sample consists of 20 extensive interviews with senior managers of German
firms. The interviews were recorded and transcribed to paper. This sample is
developed from a contact list offered by German Industry Commerce Office. The
sample was randomly selected. In total, 45 firms were contacted.
The firms interviewed vary widely in their respective industries and sizes. The
interviewees also occupy different positions in their respective firms, e.g. sales and
marketing, production and logistics, acquisition and merges, and owners for
instance. In addition, these firms are in different stages of their developments in
China, 15% of them just start their business with China via export/contracting, 25%
of them have their representative offices in China, 60% of them have invested in
China either via a JV or via a WOFV. Table 7.2 describes the sample in detail.
The sample is a good representative of the total population of the German firms
investing in China. This argument is based on two criteria, namely the distribution
of industrial sectors and the distribution of firm sizes. According to Buch et al.
(2003), among the 1500 German investors in China, approximately 74.1% are from
manufacturing sectors. As showed in Table 7.2, our sample is consisted of 17 firms,
which already invested in China or at least have a representative office. Among
these 17 firms, 13 of them are from manufacturing sectors (i.e. 76.4%). In respect to
firm size, Trinh (2004) identified that 10-20% of German investors in China are
SMEs, in our sample, 3 firms among these 17 investors are SMEs (i.e.
approximately 17.6%).
7.2.2 The questionnaire and variables
Questionnaire
The interviews followed a semi-structured questionnaire, which consists of open
as well as closed questions. This structure is based on a good understanding of the
difference between qualitative and quantitative analysis (Oppenheim 1992 p.115,
116
Malhotra 1996, Bill 2000). The overall questionnaire has 12 questions. Most of the
interviews lasted more than 30 minutes exceeding the preset 25 minutes.
Table 7. 2 Sample profile
No. Employees Interviewee title Industry Entry mode 1 1 1100 Managing director Automotive
2 18000 Assistant Chairman Food
3 160 Owner Logistics
2 1 1272 APC sales manager Machinery
2 8391 Export manager Machinery
3 200 Managing director Machinery
4 80 Owner Machinery
5 1637 Managing director Retailing
3 1 18173 Vice president Automotive
2 12600 APC General manager Furniture
3 708 CEO Garment
4 73221 CEO Shanghai Media
5 260 Managing director Machinery
4 1 4500 Vice CEO and CFO Banking service
2 4100 Company speaker Building
3 120000 Manager Consulting
4 2100 Managing director Machinery
5 500 Managing director Machinery
6 1600 Production manager Machinery
7 600 CEO China Office products
Note: As coded later, 1, 2, 3, 4 in the column of entry mode represent export/contracting, representative office (RO), joint venture (JV), and wholly owned foreign venture (WOFV) respectively.
Dependent variable
As defined in chapter 3 and 4, entry mode is defined by the ownership ratio; and it
is a continuous variable ranging from zero to one. Entry mode is the dependent
variable.
Prior literature usually classify entry modes by applying the measure of resource
commitment level thereby the level of control (Anderson and Gatignon 1986, Klein
117
et al. 1990, Leung et al. 2003, and Helpman et al. 2004). As widely accepted, a high
level of control involves regularly a high level of risk (Anderson and Gatignon
1986), therefore the risk involved is also a meaningful measure of classifying entry
modes. It is reasonable to assume that the decision makers will increase their time
consumption on their entry decisions with the increase of resource commitment and
the risk. As a result, three dimensions (i.e. the resource commitment, the risk and the
time) can be applied to classify entry modes into four clusters as depicted in Table
7.3. These four alternatives have been widely discussed in prior literature, and they
are the most usually adopted entry modes in practice (Erramilli and Rao 1993,
Tschoegl 1997, Meyer 2001).
Table 7.3 Key characteristics of entry mode alternatives with coding
Constructs
Entry mode
Code Resource commitment Risk Time of decision
Trade/contracting (Tr.) 1 quite low Qu quite low quite short
Representative office (R.O.) 2 Low low short
JV 3 high high long
WOFV 4 quite high quite high quite long
Independent variables
Firm size. This is an important characteristic variable of an organization. There
is no generally accepted definition for SMEs (Lu and Beamish 2001). In addition,
there is no generally accepted definition for large firms or MNEs either. According
to the American Small Business Administration (SBA), the most widely used
definition in terms of the number of employees of SMEs is that those firms with less
than 500 employees are SMEs (Lu and Beamish 2001). Therefore, firms above this
level of employment can be obviously clustered as large firms. According to our
sample, 75% of the observations are above this level. Analyzing the influence of
firm size on entry mode choice under such a 2-equivalent-distance scale does not
offer deep insights. Therefore, a 3-equivalent-distance scale is introduced to collapse
those firms with more than 500 employees into two further groups, namely the large
firms with employees from 500 up to 9999, and MNEs with employees exceeding
10000. The coding of firm size in terms of employees is given in Table 7.4.
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Perceived risk. In the existing literature, this factor is widely assumed as an
important country factor influencing entry mode choice (Anderson and Gatignon
1986, Errmalli and Rao 1993, Rasheed 2001, Brouther et al. 2002, Cristina and
Esteban 2002). This factor contains multiple facets, e.g. political risk or legal risk
(Williamson 1985, Gatignon and Anderson 1988), environmental uncertainty
(Anderson and Gatignon 1986, Rasheed 2001), cultural risk (Geringer and Herbert
1991), and operational risk (Rasheed 2001). For simplicity, an assessment of the
overall country risk of investing in China is asked during the process of the
interviews. This risk is classified into three categories, namely low risk (coded 3),
medium risk (coded 2), and high risk (coded 1).
Market potential. This is also an important factor indicating the host country
characteristics, and it was also widely examined in the existing empirical entry mode
studies (Agarwal and Ramaswami 1992, Agarwal 1994, Chen and Hu 2001). A 3-
equivalent-distance scale measure is also introduced to classify this variable. If the
market is perceived to be very big, then it is coded 3, medium 2, and small 1.
Tax regime. This is another important factor measuring the characteristics of the
host country (Decker and Zhao 2004 b, c). This factor was also widely studied in the
existing empirical literature (Boskin and Gale 1986, Tung and Cho 2000, Kerr and
Peter 2001). Similarly, a 3-equivalent-distance scale is applied to measure the extent
of this variable’s favorability.
Risk aversion. The decision maker’s characteristics are assumed to influence the
entry mode choice significantly (Hermann and Datta 2002, Pan 2003, Decker and
Zhao 2004 b,c). However, the decision maker’s attitude toward risk, i.e. risk
orientation or risk aversion, has not been widely studied in the relevant literature
(Pan 2003).
Applying a 3-equivalent-distance scale, the above independent variables are coded
in Table 7.4. These variables can be read as categorical even though they were
originally continuous.
119
Table 7.4 3-equivalent-distance scale coding of independent variables
Codes
Components
1
2
3
Risk Aversion Slight Strong Very strong
Tax Regime Unfavorable Favorable Very favorable
Potential Market Size Small Big Very big
Firm Size SMEs (N<= 499) Big sized (N<= 9999) MNEs (N>= 10000)
Perceived Risk Low High Very high
Note: N denotes the number of employees.
7.2.3 The data
As suggested, there are some general assumptions for empirical tests, parametric
or non-parametric (Pallant 2001, Stevens 2002). Violation of them may or may not
influence the power and/or the reality of the analysis results significantly.
According to Pallant (2001) and Stevens (2002), parametric tests have some
general assumptions: continuous rather than categorical measure of dependent
variable, random sampling, independence of observations, normal distribution of the
data, and homogeneity of variance. However, non-parametric tests have far less
restrictive assumptions on the data: random sample and independence of the
observations only.
Obviously, the first three conditions of parametric tests (i.e. continuity of the
dependent variable, random sampling, and independence of observations) are
satisfied by our data; and therefore, nonparametric methods can be applied to test the
hypotheses. We need to further examine the normality of data distributions and the
homogeneity of variance to ensure that parametric methods applicable.
The normal distribution of scores of each independent variable on the dependent
variable can be checked via a graphical or via non-graphical method. However, with
a small or moderate sample size, it is difficult to tell whether the non-normality is
real or apparent because of the considerable sampling error. Therefore, a non-
graphical test is preferred (Stevens 2002, p.264). Additionally, the author argued
120
that Shapiro-Wilk test was the most powerful one in detecting the departures from
normality (Stevens 2002, p.264), the results of which are reported in Table 7.5.
Table 7.5 Tests of normality Firm size Risk averse Market size*
Entry Mode Statistic df Sig. Statistic df
Sig.
Statistic df Sig.
1 0.945 4 0.683 0.684 5 0.006
2 0.769 11 0.004 0.895 10 0.191
3 0.828 5 0.135 0.833 5 0.146 0.857 18 0.011
Income tax ** Perceived risk***
Entry Mode
Statistic df Sig. Statistic df Sig.
1 0.825 9 0.039
2 0.911 10 0.287 0.780 9 0.012
3 0.730 10 0.002
*: No observations when Market size=1, and the range of Market size=2 is 2. **: No observations when Income tax=1. ***: Entry mode is constant when Perceived risk=3. This has been omitted.
A non-significant result (Sig. value of more than 0.05) indicates normality. Table
7.5 indicates that firm size, risk aversion are roughly normally distributed except
that one group in each variable is non-normally distributed. Controversially, market
size, income tax, and perceived risk are non-normally distributed.
What are about the homogeneities of variance? The results of the homogeneity
tests are recorded in Table 7.6. All of the significant values are greater than the
critical value of 0.05; therefore, none of them violates the homogeneity of variance.
Table 7.6 Test of homogeneity of variances
Firm size Levene Statistic
df1 df2 Sig. Risk
aversion Levene Statistic
df1 df2 Sig.
1.257 2 17 0.310 0.719 2 17 0.502
Market size
Levene Statistic
df1 df2 Sig. Income
tax Levene Statistic
df1 df2 Sig.
0.023 1 18 0.880 0.107 1 18 0.747
Perceived risk
Levene Statistic
df1 df2 Sig.
2.104 2 17 0.153
121
7.2.4 The methodology
Qualitative and quantitative studies are the two most frequently used
methodologies in marketing. These two methodologies are complementary rather
than compete; however, both have their strengths and weaknesses (Gordon and
Langmaid 1988, Malhotra 1996).
According to Gordon and Langmaid (1988), qualitative research is mainly applied
to understand rather than to measuring the marketing behavior, and it is extremely
helpful in describing complex behavior in detail. In addition, qualitative research
takes advantage of flexibility, depth of understanding, and of penetrating the
rationalized or superficial response. This method has been widely applied in
marketing research to form hypotheses or to increase understanding since the late
1970s. However, this method suffers from the fact that its results are easily misused
if they are regarded as conclusive or if they are used to generalize from the
population of interest (Malhotra 1996). Quantitative analysis, on the other hand, is
more rigorous and conclusive; but it suffers from the lack of understanding the true
behavioral process (Malhotra 1996).
For the reasons stated above, both qualitative and quantitative methods will be
applied to complement each other in our context.
Regarding the quantitative method, both parametric and non-parametric methods
will be applied to test the propositions suggested in previous chapters. Even if the
normal distribution assumption is violated as indicated earlier, a parametric method
might still be applicable. This is because, as Stevens argued, the violation of normal
distribution has only a slight effect on the level of significance (Stevens 2002,
p.261). Similarly, Pallant (2001, p. 98) argued that many statistic writers think that
most of the parametric approaches tolerate minor violations. Additionally, the
parametric methods are assumed to be more powerful and sensitive than their non-
parametric cousins, and it is always better to use a parametric technique if it is
possible (Pallant 2001, p.255). A corresponding non-parametric method is also
applied to validate the results of the parametric method.
Parametrically, the one-way Analysis of Variance (ANOVA) is used. This method
is applicable for the following reasons: firstly, among all the parametric techniques
122
(e.g. Cross-tabulations, T-test, and Analysis of Covariance), the ANOVA techniques
are used especially when the independent variables have more than two groups. In
particular, the one-way ANOVA is applicable while there is only one independent
variable, the two-way ANOVA is used while there are two independent variables,
and the multivariate ANOVA is used when there is more than one dependent
variable. Secondly, it was widely applied in the entry mode literature (Li et al. 2001,
Brouthers et al. 2002).
Non-parametrically, the Kruskal-Wallis test is the corresponding alternative to the
one-way ANOVA (Pallant 2001, p.263). It allows one to compare the scores on a
continuous variable for three or more groups. There are only two variables in each
test, a continuous dependent variable, and a categorical independent variable with
three or more categories.
Qualitative tests aim to improve the understanding of and thereby lead to the
theses on the possible influences of the organizational factors, e.g. organizational
philosophy and organizational experience, on entry mode choice, which were
proposed in chapter 5.
7.3 Analyses and results
7.3.1 Factors influencing choice of China for FDI
FDI destination choice is not a new topic in international marketing. The existing
literature claims that the factors from the perspectives of politics, economics,
culture, and population are important considerations when selecting a market for
international activities (Paliwoda and Thomas 1998).
However, what factors motivate the German firms to invest in China? The
answers to this question are presented in Table 7.7.
Inspecting the answers carefully, one is not surprised to see the variety of factors
that influence the choice of China as FDI destination. The relevant factors are
mainly organization specific, environment specific and market specific. This finding
is consistent with the existing literature as indicated in chapter 2 (see page 18) and is
similar with that of Gilmore et al. (2003). However, surprisingly and on a different
123
note, a contingent factor (i.e. the availability of a right local representative) was
another aspect that influenced German firms’ decision to enter China.
Table 7.7 Factors influencing German firms’ choice of China for FDI
Category Factors Frequency Percent-age
Descriptive words
Globalization strategy
4 20% Global strategy, follow this global trend Organization-
specific factors Client-driven strategy
7 35% Stay with clients, follow our clients, BMW, Siemens, Volkswagen
Economic development
2 10% Leading economy, conditions better and better, huge economy
Government /policy
2
10%
Central and efficient, free market, government investment in agriculture industry
Business community
1
5%
MNEs present, not alone
Employment policy
1
5%
Not risky of firing people
Environment-specific Factors
Competitor -driven Chinese people
1 3
5%
15%
Our competitor has already produced in China Ambitious, commercial, flexible, good willingness to work
Transaction cost
1
5%
High tariff
Production cost
3
15%
Cost only 25% of Germany (labor intensive industry)
Market price
2
10%
We procure from china for low price, to be competitive in Chinese market
Product quality
1
5%
Procure for good quality and low price
Delivery/ Close to market
4
20%
Close to market, easy technology adaptation
Market- specific Factors
Market size
10
50%
Greatest, huge, dynamic, growing, attractive, no.1 in next 10 years in our industry
Decision- maker
Contingent personnel
3
15%
We met Dr… , we met a distributor, I am familiar with China
Sum 15
Note: In case one interviewee may have more than one argument for their presence in China, the sum of the frequency may therefore be larger than the sample size 20.
124
As suggested by Erramilli (1991), market selection and entry mode choice are
intertwined. Therefore, the above-identified factors confirm this belief and thereby
the systematic framework of entry mode choice.
Table 7.7 indicates also that market specific factors are the most important
considerations during the process of market choice. In accordance with Gilmore et
al. (2003), the market specific factors cover those cost-related ones, like material
and labor. However, our results show that the revenue-related factors, such as
market price and market size, and the service-related factors, such as the delivery
time, and being close to market, are equally important. Not surprisingly, market
potential is the most important incentive of German firms’ decision to invest in
China, 50% of the interviewees argued that their presence in China is due to the big
market potential.
Table 7.7 also points out that the organizational strategy, i.e. the strategy of
following clients and the strategy of globalization, is another important cluster
influencing market choice. Thirty five percent of the interviewees stated that their
clients droved them to China, 20% argued that going to China was just a part of their
globalization strategies.
Many firms (small, medium, or even big) decided to be present in China just
because their MNE clients such as BMW, Volkswagen, and Siemens are there. This
finding is consistent with the arguments of several network economists. Lindqvist
(1991) suggested that the choice of a small firms’ entry mode is influenced by their
close relationships with customers. Bell (1995) recommended that the small firm’s
network relationship could lead to a client following. Coviello and Munro (1997)
again found that a network together with the experience increased by network
relationships facilitate the small firms’ potential market entry as well as the resource
commitment level for their foreign market entry.
In terms of the environmental factors, economic development index, political
stability, and government favorability are found to be influential to market choice.
Besides, it is amazing enough that 15% of the interviewees argued that their basis
for investment in China was due to the Chinese people. They thought that Chinese
people are ambitious, hard working, and commercial.
125
These results have important implications for the policy makers in the host
country. Firstly, German firms have decided to enter into China mainly for the huge
market conditioned on its political stability, and aggregate economic growth. This
motivation confirms the result of IBM’s survey that the global CEOs are focusing
more and more on revenue increment rather than cost controlling (see Chapter 4).
For such a country as China, where the growth of the economy significantly benefits
from FDI, it is very important to keep political stability no matter what the
circumstances are. While guaranteeing a continuous economic growth, it is very
important to improve its market mechanism. Secondly, many German SMEs’ and
even large firms’ investment in China was driven by those MNEs, such as BMW,
Siemens, and Volkswagen. Therefore, it is necessary and important for the
government to establish a special organization to monitor these MNEs for their
successful development in China. Thirdly, it is necessary to strengthen the school-
education system and to improve its social off-school training system to offer highly
qualified and skilled employees. Meanwhile, it is necessary to standardize its law of
employment to guarantee the employees’ benefits in case of employers’ free riding
behaviors.
At least three managing directors’ answers confirm above implications:
“We did not invest in Romania but in Czech, because of the automotive industry
in Czech is better,…, we did not invested in India, if you compare India with China
the only advantage of Indian is that everybody can speak English”, “We did not
invest in Russia, because we think Russian is not stable (politically).”
7.3.2 Parametric tests of the hypotheses
The procedures applied
Testing of the hypotheses will follow the standard procedures formulated by
Pallant (2001) in the guidelines of applying ANOVA:
1. describe the data and check whether there is any missing data,
2. test for homogeneity of variances: this is to see whether the assumption of
variance homogeneity for statistical techniques when comparing groups is
126
violated or not. Previous results point to no violations, therefore, this step
is omitted in the following,
3. ANOVA: this is to see whether there are statistically significant
differences among the mean scores of different groups; if yes, implement
the next step,
4. multiple comparisons: this is to show which group is different from the
other,
5. means plots: this step provides an intuitive way to describe the mean
scores of different groups, and to indicate a rough direction of difference.
Risk aversion (Decision maker)
Proposition 3.1 can be translated into:
1 2 30 : rs rs rsH µ µ µ= =
1 2 31 : rs rs rsH µ µ µ≠ ≠ .
The null hypothesis states that the decision makers with three different attitudes
toward risk choose their entry modes homogenously on average. Alternatively, the
decision maker’s attitude toward risk does not influence his choice of entry mode
significantly. If the null hypothesis is rejected, then a significant influence of the
decision maker’s attitude toward risk on entry mode choice can be concluded.
(1) Data description
Table 7.8 Data description (risk aversion-entry mode)
Risk
aversion N
Entry
mode Mean
Std.
Deviation
Std.
Error
95% Confidence
Interval for Mean
Mini-
mum
Maxi-
mum
Lower
Bound
Upper
Bound
1 5 3.60 0.548 0.245 2.92 4.28 3 4
2 10 2.80 1.033 0.327 2.06 3.54 1 4
3 5 2.00 1.225 0.548 .48 3.52 1 4
Total 20 2.80 1.105 0.247 2.28 3.32 1 4
Table 7.8 indicates at least two important points: firstly, there is no data missed;
secondly, the distribution of entry mode of the three groups of decision makers in
127
terms of risk aversion. Clearly, 50% of the decision makers hold a medium attitude
toward risk, and in average they choose an equity mode (i.e. mean score = 2.8).
Decision makers with a lower attitude toward risk (around 25%), choose a higher
equity entry mode with a mean score of 3.6. The other 25% holding a higher attitude
toward risk adopt a lower equity entry mode with a mean score of 2.0. This result
roughly indicates a negative relationship between decision maker’s risk aversion and
entry mode choice.
(2) ANOVA
Table 7.9 ANOVA (risk aversion-entry mode)
Variance Sum of Squares df Mean Square F Sig.
Between Groups 6.400 2 3.200 3.238 0.064
Within Groups 16.800 17 0.988
Total 23.200 19
The ANOVA result indicates clearly that the mean scores of these three groups’
variances are not significantly different at a traditionally significant level, 0.05α = .
However, as suggested by Stevens (2002), it is necessary to adjust the α level to
compensate the small sample size (N<=30), and 0.1α = is suggested when handling
a small sample size (Pallant 2001, Stevens 2002). Under such an adjusted
significance level, the null hypothesis is rejected. Therefore, a significant influence
of decision makers’ attitude toward risk on entry mode choice can be concluded.
The multiple comparisons and/or means plots show where the difference lies.
(3) Multiple comparisons
Two groups of test can be used to identify the group differences, namely the
planned (or priori) comparisons and the post hoc comparisons. The former is applied
to compare a subset rather than a whole set of group pairs. This method does not
control the increased risk of Type 1 errors. Alternatively speaking, there is an
increased risk of thinking that you have found a significant result when in fact it
could have occurred by chance. Through comparing the whole set of group pairs, the
latter can reduce the risk of making Type 1 errors largely (Pallant 2001). Therefore,
we apply the post hoc tests in our context.
128
Additionally, a number of post hoc tests are applicable to make multiple
comparisons; they differ in nature and assumptions. The two most commonly used
post hoc tests are the Turkey’s Honestly Significance Difference test and the Scheffe
test. Of the two, the Scheffe test is the most cautious method for reducing the risk of
type 1 error, but it is less likely to detect a difference between groups. The Turkey’s
Honestly Significance Difference (HSD) test is therefore the more common used
approach (Pallant 2001). The results of the Turkey’s HSD tests are presented in table
7.10.
Table 7.10 Multiple comparisons (dependent variable: entry mode)
Turkey HSD (I) Risk averse
(J) Risk averse
Mean Difference (I-J) Std. Error Sig.
90% Confidence Interval
Lower Bound
Upper Bound
1 2 0.800 0.544 0.330 -0.40 2.00 3 1.600(*) 0.629 0.052 0.22 2.98
2 1 -0.800 0.544 0.330 -2.00 0.40
3 0.800 0.544 0.330 -0.40 2.00
3 1 -1.600(*) 0.629 0.052 -2.98 -0.22 2 -0.800 0.544 0.330 -2.00 0.40
* The mean difference is significant at the 0.1 level.
Explicitly, there is a significant difference (at 0.1α = ) between the high-risk
averse and low-risk averse decision maker in terms of their entry modes. In addition,
the signs of mean differences resulting from the bilateral comparisons explain that
entry mode choice is related negatively with the decision maker’s risk aversion. The
means plots in Figure 7.6 highlight this relationship.
Proposition 3.1 that predicted a negative relationship between entry mode choice
and the decision maker’s risk aversion is therefore supported by this empirical study.
This finding is also consistent with Pan (2003).
129
Figure 7.6 Means plots (risk aversion-entry mode)
1 2 3
Risk averse
2
2,5
3
3,5
4
Mea
n of
Ent
ry M
ode
Firm size (Organization)
Referring to Proposition 4.1, we recognize that different sized firms have different
organizational structures, and they choose their entry modes in different contexts;
therefore, they adopt different strategies for their entry mode choice. However, the
influence of firm size, when it was isolated from other contingent factors (e.g.
country policies, firms’ strategies, and industry or product specifications) on entry
mode choice become ambiguous. Therefore, we develop the following hypothesis
for test.
1 2 30 : fs fs fsH µ µ µ= =
1 2 31 : fs fs fsH µ µ µ≠ ≠ .
This null hypothesis states that three groups of firms (SMEs, large firms, and
MNEs) have homogenous mean scores of entry modes. This indicates that the firm
size does not influence the choice of entry mode significantly. If this null hypothesis
was rejected, it implies that firm size influences entry mode choice significantly.
(1) Data description
Table 7.11 Data description (firm size-entry mode)
Firm size N Mean
Std. Deviation
Std. Error
95% Confidence Interval for Mean
Mini- mum
Maxi- mum
Lower Bound Upper Bound
1 4 2.00 0.816 0.408 0.70 3.30 1 3
2 11 3.09 1.136 0.343 2.33 3.85 1 4
3 5 2.80 1.095 0.490 1.44 4.16 1 4
Total 20 2.80 1.105 0.247 2.28 3.32 1 4
130
Obviously, there is no missing data during the process of test. Fifty five percent of
the firms are big sized ones with employees greater than or equal to 500. These
firms in average choose JVs as their entry modes in China (mean = 3.09). Twenty
percent of the firms are SMEs, and the other 25% are MNEs. The SMEs have a
lower average score (mean = 2.0) of entry modes than that of MNEs (mean = 2.8).
However, this gap is not very large. Interestingly, in each of these three groups,
there is at least one firm entering into China via export/contracting, but the other
firm entering via a high equity mode, i.e., JV or WOFV. This indicates that there is
no linear relationship between firm size and entry mode choice.
(2) ANOVA
Table 7.12 ANOVA (firm size-entry mode)
Sum of Squares Df Mean Square F Sig. Between Groups 3.491 2 1.745 1.506 0.250
Within Groups 19.709 17 1.159
Total 23.200 19
The significance value of ANOVA test is 0.250, which is not significant. Thus,
the null hypothesis is not rejected. This statistical result is consistent with the
implication made from the sample descriptions. Therefore, firm size is not a
significant determinant of entry mode choice. Additionally, the means plots in
Figure 7.7 prove this result.
Figure 7.7 Mean plots (firm size-entry mode)
1 2 3
Firm size
2
2,2
2,4
2,6
2,8
3
3,2
Mea
n of
Ent
ry M
ode
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The insignificance could arise for two reasons: one is due to the small sample
size, and the other is due to the stronger impact of other factors such as industry
difference and/or host country policies.
Among the three firms entering into China via export/contact, one is a MNE,
which is in food industry; one is a big firm in the automotive industry, and the other
is a small firm in the logistics industry. It is not so difficult to understand why the
MNE has not decided to invest China yet, by referring to his argument:
“China is such a different market (i.e., in the perspective of consumer tastes
among others) compared with European markets, we do not have any prior
experience about this market, additionally, and we need a long time period
to break even”.
In respect to the host country policy, it is well known that the Chinese government
does not allow WOFV for the whole car manufacturing; this policy aims to protect
its national automotive industry. Even for the automotive part manufacturers, there
is a stringent restriction on their ownership ratios in the JVs, and on the number of
JVs they can build in China. Therefore, it is not strange to see in our sample, the
automotive MNE invested in China via a JV but not a WOFV. Additionally, many
other MNEs, such as Volkswagen, BMW, DaimlerChrysler and Robert Bosch, fall
into the same class.
Therefore, firm size as a predicting factor of entry mode choice is insignificant.
This result is consistent with the findings in Reuber and Fisher (1997) and Evans
(2002), where firm size was not concluded to be significant either.
However, this result has nothing to say about the validity of previous
understanding that firms in different sizes might choose their entry mode strategies
differently.
Market potential (Environment)
In correspondence to proposition 3.4(a), the influence of market size on entry
mode choice is formulated as:
1 2 30 : ms ms msH µ µ µ= =
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1 2 31 : ms ms msH µ µ µ≠ ≠ .
This null hypothesis states that firms with different perceptions on the potential of
the Chinese market, small, big, or very big, have homogenous mean scores of their
entry modes. Alternatively, the host country market potential does not affect the
choice of entry mode significantly. Again, if this null hypothesis is not rejected, it
means that market potential is not a significant factor influencing entry mode choice.
(1) Data description
Table 7.13 Data description (potential market size-entry mode)
Market size N Mean
Std. Deviation
Std. Error
95% Confidence Interval for Mean
Mini-mum
Maxi-mum
Lower Bound Upper Bound 2 2 3.00 1.414 1.000 -9.71 15.71 2 4
3 18 2.78 1.114 0.263 2.22 3.33 1 4
Total 20 2.80 1.105 0.247 2.28 3.32 1 4
It is obvious that there is no missing data during the test. However, due to our
small sample size, there are only two attitudes identified toward the potential of the
Chinese market, i.e. big or very big. Only 10% of them thought that the Chinese
market is big; the other 90% think it very big. Astonishingly, the average mean score
of entry modes is lower for those who perceive the Chinese market as bigger. This
can be explained by the small number of interviewees who perceived the market as
big only, and by the big number of those who perceived the market as very big. The
latter disperse widely in their entry modes from export/contracting to WOFV. The
average score of entry modes is 2.78. In contrast, between the two firms who
perceived the market big only, one invested in China with a WOFV, the other
invested with a R.O., the mean score is explicitly higher, i.e. the mean score is 3.0.
Evidently, the slight difference between the two groups’ mean scores of entry
modes implies that market size, in the context of China, is not a significant
determinant of entry mode choice, even though it is an important driver of market
choice.
(2) ANOVA
133
Table 7.14 ANOVA (potential market size–entry mode)
Sum of Squares Df Mean Square F Sig. Between Groups 0.089 1 0.089 0.069 0.795
Within Groups 23.111 18 1.284
Total 23.200 19
The significance value of this test is obviously greater than the criterion of 0.1; the
null hypothesis is therefore not rejected. This verifies the implication concluded
from the data description. Additionally, the means plots in Figure 7.8 indicate
however a slight negative relationship between entry mode choice and market size.
Figure 7.8 Mean plots (market size-entry mode)
2 3
Market size
2,75
2,8
2,85
2,9
2,95
3
Mea
n o
f E
ntr
y M
od
e
Based on large sample surveys, Agarwal and Ramaswami (1992), Agarwal
(1994), and Chen and Hu (2002) concluded a positive relationship between entry
mode choice and market size. However, Smarzynska (1999, p.15), also through a
large sample survey, concluded that:
“It has been shown that the market size is an important factor in the decision
to undertake FDI. At the same time, it is unlikely to affect the choice of entry
mode.”
Our result is explicitly consistent with Smarzynska (1999), in which an
ambiguous relationship between entry mode choice and market size was concluded.
Estimated risk of host country (Environment)
In correspondence to Proposition 3.2 we can hypothesize a negative influence of
estimated risk of the host country on entry mode choice and formulate it as:
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1 2 30 : er er erH µ µ µ= =
1 2 31 : er er erH µ µ µ≠ ≠ .
The null hypothesis means that the mean scores of entry modes of these three
groups of firms, which perceive differently on the risk of investing in China, namely
low, high, or very high respectively, are homogenous. Stated differently, the
estimated risk of host country does not influence the choice of entry mode
significantly. If the null hypothesis is rejected, then it means that the estimated risk
of host country is a significant predictor of entry mode choice.
(1) Data description
Table 7.15 Data description (estimated risk-entry mode)
Estimated risk N Mean
Std. Deviation
Std. Error
95% Confidence Interval for Mean
Mini-mum
Maxi-mum
Lower Bound
Upper Bound
1 9 3.11 1.054 0.351 2.30 3.92 1 4
2 9 2.89 0.928 0.309 2.18 3.60 2 4
3 2 1.00 0.000 0.000 1.00 1.00 1 1
Total 20 2.80 1.105 0.247 2.28 3.32 1 4
This description finds no missing data during the test. Additionally, this
description shows that 45% of the interviewees think that the risk of investing in
China is low, the other 45% think it high, and the remaining 10% think it very high.
The mean scores of entry modes decrease gradually with the increase of the
estimated risk of investing in China.
This specifies a negative relationship between these two variables. Apparently, the
two interviewees having a very high estimation on the risk of investing in China,
adopted a non-equity entry mode, i.e. export/contracting.
(2) ANOVA
Table 7.16 ANOVA (estimated risk-entry mode)
Sum of Squares df Mean Square F Sig. Between Groups 7.422 2 3.711 3.999 0.038
Within Groups 15.778 17 0.928
Total 23.200 19
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The ANOVA test demonstrates that the significant value is less than the
traditional level of 0.05. Hence, there is a significant difference among the mean
scores of these three groups’ entry modes. Therefore, the null hypothesis is rejected.
(3) Multiple comparisons
Table 7.17 Multiple Comparisons (Dependent Variable: Entry mode)
Tukey HSD
90% Confidence Interval Estimated risk
Estimated risk
Mean Difference
Std. Error Sig. Lower Bound
Upper Bound
1 2 0.222 0.454 0.877 -0.78 Jan 22 3 2.111(*) 0.753 0.031 0.45 Mrz 77 2 1 -0.222 0.454 0.877 -1.22 0.78 3 1.889(*) 0.753 0.056 0.23 Mrz 55 3 1 -2.111(*) 0.753 0.031 -3.77 -0.45 2 -1.889(*) 0.753 0.056 -3.55 -0.23
* The mean difference is significant at the 0.1 level.
The multiple comparisons explain that those with a higher expectation of the risk
of investing in China differ significantly with those with a lower expectation in
terms of the mean scores of entry modes. Additionally, the means plots in Figure 7.9
confirm a negative relationship between the estimated risk and entry mode choice;
this is consistent with the observation from data description.
Figure 7.9 Mean plots (estimated risk-entry mode)
1 2 3
Estimated risk
1
1,5
2
2,5
3
3,5
Mea
n o
f E
ntr
y M
od
e
These results support greatly the normative prediction of Proposition 3.2, where a
negative relationship between the estimated risk and entry mode choice was
proposed. Additionally, this result is also consistent with prior empirical literature,
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Errmalli and Rao (1993), Chen and Martin (2001), and Nakos et al. (2002), are for
example. However, there is also prior literature concluding a controversial
relationship, Rasheed (2001) found that country risk is positively related to entry
mode choice. Furthermore, Oviatt and McDougall (1997) found an insignificant
relationship, and Pan (2003) found a dummy relationship between these two
variables, for instance.
Tax regime (Environment)
Corresponding to the Proposition 3.4(c), the hypothesis on the influence of tax
regime on entry mode choice is expressed as:
0 1 2 3: tr tr trH µ µ µ= =
1 1 2 3: tr tr trH µ µ µ≠ ≠ .
This null hypothesis states that the average entry modes of these three different
groups in terms of different evaluations on the favorability of tax regime in China
are homogenous. Put differently, the tax regime does not influence the entry mode
choice. Rejecting the null hypothesis suggests a significant influence of tax regimes
on entry mode choice.
(1) Data description
Table 7.18 Data description (tax regime-entry mode)
Tax favorability N Mean
Std. Deviation
Std. Error
95% Confidence Interval for Mean
Mini-mum
Maxi-mum
Lower Bound
Upper Bound
2 10 2.30 0.949 0.300 1.62 2.98 1 4
3 10 3.30 1.059 0.335 2.54 4.06 1 4
Total 20 2.80 1.105 0.247 2.28 3.32 1 4
Again, due to the small sample size, we identify only two attitudes toward the
favorability of tax regimes, i.e. 50% of the interviewees evaluate the tax regimes of
China favorably, the other 50% think that the tax regimes in China are very
favorable. No one thinks that it is unfavorable. Those with a very favorable
evaluation have a much higher mean score of entry modes (mean = 3.3) than that of
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those with a medially favorable evaluation (mean = 2.3). This implies a positive
relationship between the tax regimes favorability and entry mode choice.
(2) ANOVA
Table 7.19 ANOVA (tax regime-entry mode)
Sum of Squares df Mean Square F Sig. Between Groups 5.000 1 5.000 4.945 0.039
Within Groups 18.200 18 1.011
Total 23.200 19
Obviously, the null hypothesis is rejected with a significance level of 0.039,
which is even lower than the traditional level of 0.05. This means that these two
groups having different perceptions of the tax favorability of China choose their
entry modes differently in average.
Because there are fewer than three groups, i.e. nobody thinks the tax regimes in
China unfavorable, the post hoc test for entry mode cannot be implemented (Pallant
2001). However, the data description and the means plots in Figure 7.10 show
explicitly the direction of this relationship between entry mode and tax regimes.
This empirical result supports the predictive proposition made in chapter 3 that
entry mode choice is positively related to the tax incentives of the host country.
Additionally, this test corresponds to the outlook in Wilkinson and Nguyen (2003,
p.56) that it is necessary to further inspect the influence of host country market
characteristics (e.g. tax rules, macro economic parameters) on entry mode choice.
Figure 7.10 Means plots (tax regime-entry mode)
2 3
Income tax rate
2,2
2,4
2,6
2,8
3
3,2
3,4
Mea
n of
Ent
ry M
ode
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Summing up
The one-way ANOVA analysis results indicate that the decision maker’s risk
aversion and two country characteristics (i.e., the estimated risk and the tax regime)
are three significant determinants of entry mode choice. Market size and firm size
are not predictive in terms of entry mode choice in our context. However, this does
not mean that the organization itself is irrelevant for the entry mode choice. The
qualitative analyses in next section discover a great dependence of entry mode
choice on the organization related factors, such as the organizational philosophy and
experience.
Moreover, the results validate a negative relationship between the decision
maker’s risk aversion, the estimated risk and entry mode choice, and a positive
relationship between the tax regime favorability and entry mode choice.
7.3.3 Non-parametric tests of the hypotheses
As indicated explicitly in the previous sections, the Kruskal-Wallis test is the non-
parametric alternative of one-way ANOVA, it will be applied to confirm the results
of one-way ANOVA. All of the assumptions of the Kruskal-Wallis test are satisfied.
The results of Kruskal-Wallis tests are summarized in Table 7.20.
Table 7.20 Kruskal-Wallis tests statistics (a,b,c)
Risk aversion Firm size Market size Estimated risk Income tax rate
Chi-Square 4.949 3.094 0.069 5.207 4.504
Df 2 2 1 2 1
Asymp. Sig. 0.084 0.213 0.793 0.074 0.034
a Kruskal-Wallis Test b Grouping Variable: Risk aversion, firm size, market size, estimated risk, income tax rate respectively. c Dependent variable is entry mode
If the significance level is a value less than 0.05, then there is a statistically
significant difference in the continuous dependent variable across the different
groups of each independent variable. This significant difference implies that the
independent variable has a significant impact on the dependent variable. However,
due to the small sample, we adjust the significance level to 0.1 as we did in the
parametric tests. Apparently, risk aversion, estimated risk, and the income tax rate
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were fund to be significantly influential. In contrast, the firm size and the market
size are not significantly influential.
These conclusions made by Kruskal-Wallis tests are completely consistent with
those of one-way ANOVA.
7.3.4 Penetrating the theses
This subsection aims to analyze qualitatively the two propositions, Proposition 5.2
and Proposition 5.3 respectively.
These two propositions illustrate the possible influences of two organizational
variables, namely the organizational philosophy, and the organizational experience,
on entry mode choice.
Despite the previously analyzed advantages of quantitative analysis, a qualitative
method here is adopted for two reasons. Firstly, the organizational philosophy is
difficult to quantify; secondly, the organizational experience in the previous
empirical literature is studied typically via a quantitative analysis, a qualitative
analysis might help to find out the hidden stories in quantitative analyses.
Organizational philosophy
As acknowledged, the influence of organizational strategies (the global strategy in
particular) on entry mode choice has been frequently discussed in the existing
literature (Kogut 1988, Klein 1990, Hill et al. 1990, Kim and Hwang 1992, and
Aulakh and Kotabe 1997). However, to the best of our knowledge, the studies on the
influence of organizational philosophy on entry mode choice are quite rare.
The actual role of the organizational philosophy on entry mode choice is well
explained by the interviewees’ arguments in Table 7.21.
Table 7.21 indicates that two of the twenty interviewees argued their not investing
in China via a JV are because of their philosophies of doing things in their own way.
One interviewee argued that they decided to have only a representative office in
China due to their philosophical belief of specialization, i.e. outsourcing is always
cheaper than self-making. This philosophical belief changes their business strategy
to be a retailer. Two other employees had explained that they decided to invest via a
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WOFV instead of a JV due to the philosophical consideration of doing things fast.
Therefore, at least 25% of the interviewees argued that their choices of entry mode,
especially between a JV and a WOFV, are determined by their philosophy of how
things should being done.
The empirical results therefore support Proposition 5.2.
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Table 7.21 Arguments on the choice between JV and WOFV
Current status
Ref.
Firm size
Industry Why not JV/WOFV
1 1 Logistics Not WOFV: the local policy does not permit, necessary
2 2 Automotive Not WOFV: not invest too much, partner’s knowledge and Resource, some negative experience from others
Not entry
3 3 Food Not JV: that is our philosophy
1 2 Machinery No idea: At moment, we need to know the market first
2 2 Retailing Neither JV nor WOFV: outsourcing is always cheaper, we aim to be a retailer
3 1 Power Not JV: It is easy to do with some people we are familiar, we are afraid of technology copy.
4 2 Machinery Not JV: In 1990s, the JV is very popular, but many failed, because the culture is different, they want to do things in their own way.
Rep. office
5 1 Machinery Not JV: that is not our philosophy, do it ourselves first.
1 3 Automotive Not WOFV: to make use of our partners’ local advantages
2 3 Media Not WOFV: JV is the efficient way to expand in China
3 1 Machinery Not WOFV: not invest too much, but personally I prefer WOFV
4 3 Furniture
Not WOFV: our partner has big knowledge, difficult for a foreigner to get the land in China. But: personally, I insisted a WOFV, because I heard a lot of failure stories of JV
JV
5 2 Garment Not WOFV: our partner has advantage of communication with government; it is difficult to understand the local decision makers.
1 2 Machinery Not WOFV: We are family owned, to make decisions fast
2 2 Machinery Not JV: we read a lot of reports, usually JV is not successful
3 2 Machinery Not JV: to make decision faster
4 2 Office products Not JV: it is difficult to find a right partner in China
5 3 Consulting No idea
6 2 Banking No answer
WOFV
7 2 Building Not JV: to be responsible for own business
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Organizational Experience
A good understanding of Proposition 5.3, i.e. a gradual process of entry mode
choice, can be achieved by studying the route map of entrance.
(1) Route map of entrance
The route map describing the stages of each firm’s development in China is
presented in Table 7.22. This map describes the dynamics of their changes of entry
modes.
Table 7.22 Firms’ route map of development in China
Current status No. Industry Route map
1 Logistics Will invest with JV
2 Automotive Will invest with JV Export/contracting
3 Food Will invest with WOFV
1 Machinery No plan of investment in the near future
2 Retailing Procurement
3 Power Will invest with WOFV
4 Machinery Will invest with Tr.
Rep. office
(R.O.)
5 Machinery In far future, invest with WOFV
1 Automotive JV
2 Media JV
3 Machinery R.O. – Tr. – JV
4 Furniture JV
Joint Venture
(JV)
5 Garment R.O. – JV
1 Machinery Procurement office – R.O. – Tr. – WOFV
2 Machinery Export – Tr. – WOFV
3 Machinery R.O. – WOFV
4 Office products WOFV (production function mainly)
5 Consulting R.O. – WOFV
6 Building Investment on network
Wholly owned
foreign venture
(WOFV)
7 Banking Export – JV – WOFV
Total 20
The coexistence of each type of entry modes in the sample explains, although not
so powerfully, a gradual process of entry mode choice. The change of entry mode of
those firms that have already invested in China explains, more powerfully, a positive
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experience impact on entry mode choice. The map shows that firms usually started
with a low equity entry mode, such as export/contracting or representative office,
then with accumulated experience they switched to a high equity mode, such as a
JV, or a WOFV.
One managing director’s argument highlights this gradual process explicitly:
“We establish a representative office in China to get some knowledge about
the people, to know more about the mentality, and to get some knowledge of
the market …, later, we will establish a wholly owned venture and get in our
Chinese partners as shareholders”.
The route maps of firms’ entry mode choice find a great congruence with the idea
of the gradual-process school (Johanson and Wiedersheim-Paul 1975 and Johanson
and Vahlne 1977).
(2) Choice between a JV and a WOFV
The interviewees’ arguments on their choice between a JV and a WOFV help to
understand the “U” shaped influence of experience on entry mode choice. Their
arguments are given briefly in Table 7.21.
It is clear that 4 answers are non-informative due to the answers being either “no
idea” or “none of the alternatives will be adopted”. Among the 16 valid answers, 8
decided not to enter via a JV, the other 8 decided not to enter via a WOFV. In
addition, among the 8 who rejected WOFV, there are 2 interviewees who are
managers, and they personally preferred a WOFV even though their firm decided
not to employ this strategy. Thus, 10 of the interviewees actually preferred to enter
via a WOFV rather than via a JV.
Among the 10 WOFV supporters, 4 of them argued that their decisions were
based on the previous experience, either from the media or from other firms. Among
the 6 who supported a JV, 4 of them argued that their choices were to make good
use of their partner’s advantages of resources and communication.
Therefore, intuitively, the decision makers’ choice of entry mode, especially the
choice between a JV and a WOFV, is greatly influenced by the prior experience
accumulated by themselves or by others. If the initial investment in China was very
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successful, or what they learned from the media or other sources is positive, then
they will probably increase their investment further or make their investment
decisions, and vice visa.
The route maps, especially those of the firms having already invested in China via
a WOFV, confirm the positive influence of successful experience on entry mode
choice explicitly. This is consistent with the findings of Davidson (1980, 1982),
Anderson and Gatignon (1986), Agarwal (1994), Reuber and Fisher (1997), and
King and Tucci (2002).
To have a direct intuition on the important influence of successful and
unsuccessful experience on entry mode choice, some of the interviewees’ personal
statements are cited:
“We must succeed in one city and then we enlarge to other cities, we do
things step by step. We do not do like to calculate the population, estimate
the demand and then decide the number of offices to open, otherwise, we will
meet the problems of logistics, sales and etc”,
“I ever talked with an English guy, he made a JV with a Chinese partner,
…, finally, he stopped the JV, he used more time and more money than do it
by himself”,
“We have read a lot of reports about companies, the joint ventures have not
been successful in most cases, and maybe the management culture is too
different”,
“In 1990s, JVs are very popular, however many JVs failed, because the
culture is so different, Chinese want to do things in their own not our way”.
The interviewees’ arguments for their choice between a JV and a WOFV
complement the positive impact of experience on entry mode choice however also
with a negative side. This negative experience may arise from previous failure,
directly or indirectly. This negative experience drives German firms to favor a
WOFV instead of a JV for their investment.
Therefore, Proposition 5.3 finds a great support in this empirical test. Thus, the
“U” shaped relationship is well illustrated.
145
Furthermore, the finding of these two influential variables during the process of
choosing between a JV and a WOFV, namely experience and resource advantage,
complements the conclusions made from the theoretical framework in chapter 3, in
which the organizational impact on entry mode choice is stressed not enough.
However, this has nothing to say about the validity of the theoretical framework.
Clearly, no one can expect a theoretical framework to cover all the relevant aspects.
7.4 Conclusion
Based on semi-structured interviews, this chapter tested and illustrated some of
the propositions, which were developed in previous chapters. Implicitly, the
systematic approach of entry mode choice was investigated.
This empirical study finds great support for our systematical framework, which
essentially implies for the managers in practice, that the entry mode choice should
be made by considering simultaneously those factors from the perspectives of the
decision maker, the organization and the environment, in which the former two are
embedded. This result implies additionally for the managers in practice, that it is
beneficial for them to follow the decision-making procedures, which are depicted by
Figure 6.2, in face of entry mode choices.
The identified influence of organizational experience on entry mode choice
indicates to the managers that without sufficient knowledge about the host country a
high equity mode of entry may bring a high risk. Similarly, the accumulated
irrelevant experience does not help the managers to invest via a high equity mode in
the host country.
Additionally, the analytical relationships between entry mode choice and the
managerial attitude toward risks as well as expense indicate the shareholders the
necessity of monitoring and correcting the managerial choice of entry mode to
achieve the highest benefits.
Finally, the analytical results illustrate to the policy makers in the host country
how they should adjust their policies in respect of taxes, tariffs, and other investment
environmental parameters to attract the foreign direct investment.
146
Future work can be directed to model and/or empirically test the impact of
network, organizational philosophy and organizational experience on entry mode
choice. Our results have found explicitly a great correlation between these variables
and entry mode choice.
147
Chapter 8 Conclusions and Outlook
Based on a comprehensive analysis on the existing theories of the firm and its
market entry, this dissertation found that the latter is usually based on the former.
This relationship provides a clue as to the new methods of modeling market entry,
i.e. modeling entry mode choice through applying a new branch theory of the firm.
This result suggests a close look at how firms are studied by the organizational
scientists rather than by economists only. This dissertation studied how firms should
choose their entry mode by following a systematic logic, which was defined and
widely applied by the organizational scientists to study firms’ strategic issues.
Recognizing the fact that firms in different sizes have different organizational
structures and choose their entry modes differently in distinct environments, the
entry mode choices of the SMEs and large firms were modeled separately and
differently under a systematic framework. The alignment of management and
ownership in the SMEs allows investigating how the SMEs interact with its
surrounding environment in the process of entry mode choice. Modeling large firms’
entry mode choice by taking into account the two significant consequences of the
separation of management from ownership induces a longitude analysis with a
particular emphasis on the decision makers. The qualitative analyses in chapter 5,
for the first time, put the firm itself at the core of analysis, and complement the
normative analyses in chapter 3 and 4 with a descriptive one.
The systematic approach of entry mode choice in this dissertation differs from the
existing theories or approaches in two aspects, namely the way of modeling entry
mode choice and the correspondent results.
This method of modeling entry mode choice is from a new standpoint rather than
from the conventional economics or from the behavioral economics only. This work
aimed to be just a stool pigeon of further research on entry mode choice with a
systematic logic, with which other studies can begin.
148
In comparison with the large volume of empirical studies in recent years, this
systematic approach supplements the less passion for developing the theories of
entry mode choice. Comparing with the existing qualitative approaches (e.g. the
TCA, the OLI, etc.), this systematic approach models the choice of entry mode
quantitatively while taking the concept of efficiency into account; in this sense the
present approach complements the existing qualitative ones. Particularly, the way by
which the entry mode is modeled quantitatively in this dissertation differs from the
existing game theoretic ones, in which the decision is made more from a strategic
consideration. Additionally, the systematic framework provides not only a process-
oriented analysis of entry mode choice as depicted by Figure 6.2 but also a content-
oriented analysis as indicated by Figure 6.1.
In terms of the results concluded from the analysis of this systematic approach,
many are consistent with the existing literature, e.g. a negative influence of risk
aversion (Osland et al. 2001, Bhaumik 2003), a positive influence of market
attractiveness (Feenstra 1998), a “U” shaped influence of organizational experience
on entry mode choice (Erramilli and Rao 1991), etc. However, the influence of
managerial discretion, managerial expense preference, the organizational
philosophy, and the value system instability, on entry mode choice is, for the first
time, studied explicitly in this dissertation.
The empirical study in chapter 7 tested, quantitatively and qualitatively, part of
the propositions developed in this dissertation and thereby justified significantly the
systematic framework of entry mode choice. These results provide significant
counsel not only for the managers, the firm concerned, and the policy makers in the
host country in practice, but also for the future research.
The existing literature has shown us that entry mode choice is a complicated
strategic decision. The determinants of entry mode choice come from not only the
inside but also the outside of the firm. To make a right decision, the managers are
well advised to adopt a systematic logic, i.e. to identify the influential factors from
the perspectives of the decision makers, the organization and the surrounding
environment, and to follow a systematic analysis process as described by Figure 6.2.
For those larger firms with a complicated organization structure, the existence of
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agency costs induces a distortion of managers’ investment decisions. The firms
concerned are therefore well advised to adopt some measures to monitor and
regulate the managerial behaviors and thereby to reduce the agency costs.
Additionally, as shown by the empirical test, the significant factors influencing the
choice of a foreign market are not only the cost related ones (e.g. transaction costs,
production costs, taxes, etc.), the benefit related ones (e.g. market price, high
qualified employees, good business community, vertical value chain suppliers, etc.),
but also the risk related ones (e.g. stability, estimated risk about the market, etc.).
The policy makers of the host country are well advised to take some actions to
improve the above relevant aspects in order to attract more foreign direct
investment. The establishing of after-school education system to improve the
employees’ qualifications, lowering the income tax rate, improving the market
mechanism are examples of prudent actions that could be used to improve the
investment environment.
Our results have also shown that the importance of transaction cost considerations
in the process of entry mode decision, due to the development of information
technologies and transportation industry, are becoming more and more trivial. On
the other hand, the systematic logic provides a new attitude toward the theoretical
study of entry mode decision. Based on this systematic logic, future research could
be directed to model entry mode choice in a more integrated way. Of course, future
research can also apply other trends and strategies for the study of entry mode
choice as those being suggested in chapter 2.
Due to the cultural and physical distances between China and Germany, and the
different social, political and economic systems, it becomes more dispensable and
beneficial for German firms to apply this systematic model for their decisions of
market entry in China. Firstly, it becomes more difficult and costly for German
firms to monitor the managerial behaviors in China due to cultural and physical
distances; therefore it becomes more necessary to consider the decision maker
related factors in the process of entry mode decision. Secondly, due to the fact that
China is a very huge country having multiple hierarchies in its political system, and
that different places in different hierarchies apply different policies, taxes policy and
foreign exchange management policy are for example. Furthermore, due to the
150
national policies in China are usually not so concrete, the authorities of different
places could implement the same national policy differently. Therefore, it becomes
very important for the German investors to compare different investing
environments in the process of entry mode decisions. Last but not least, the Chinese
firms and German firms usually have distinct organizational philosophies and
organizational strategies. To make a JV with a firm having distinct philosophies
usually ends with failure. The empirical results in chapter 7 have shown this point
explicitly.
Nevertheless, this dissertation has its limitations; future work can be directed to
address the unanswered questions. Modeling of entry mode choice in this
dissertation was limited to the consideration of investment and production sectors
only; there is no consideration of the consumption sector. Other organizational
characteristics rather than what have been discussed in this dissertation may also be
important and will need to be considered. Empirically, there are still some
propositions, which were developed but not examined; therefore further work can be
directed to test them. Last but not least, a large sample sized empirical test may
improve the significance of the results concluded in this dissertation.
151
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Appendix: List of the interviewees
Dipl.-kfm Andreas Hartmann, Owner of Hartmann International
Dipl.-Betriebswirt Mathias Löwen Manager of Gildemeister AG
Mr. Wilhelm A. Böllhoff Managing Director of Wilhelm Böllhoff
GmbH & Co. KG
Mr. B. Maier Owner of B. Maier Zerkleinerungstechnik
Mr. Christian Unger, General Manager of Bertelsmann (CHINA)
Mr. Detlef Adler CEO of Seidensticker Group
Mr. Dieter Düringer, Head of Export Department of CLAAS
Mr. Eckard Heidloff, Executive Vice President and Chief Financial
Officer of Wincor-Nixdorf
Dipl.-Ing Frank-Michael Kuhnt, Director of Dürkopp Fördertechnik
Mr. Hendrik-Jan Muis, Managing Director of Gerry Weber
Dr. Heinz T. Petermann, Manager of PWC Bielefeld
Dr. Dr. Joachim Rieger, Vice President M&A, Benteler AG Mr. Lutz Werner Managing Director of Holter Regelarmaturen
Mr. Max Graf Kerssenbrock, Assistant Dr.h.c. August Oetker of Dr. Oetker
Mr. Olaf Lehmann Managing Director Sales & Marketing of
SOMMER Group
Dr. Peter G. Ulrich Manager of DaimlerChrysler AG
Dipl.-kfm Thomas Lauritzen, Speaker of Schüco International AG
Mr. Thomas Reeker, General Manager Asia Pacific Schieder Group
Mr. Volker Wagner Manager of Marketing & Sales Asia Pacific
of G. Kromschröder AG
Mr. Wolf D. Meier-Scheuven Managing Director of BOGE AG
Mr. Ye Weidong CEO of Növus AG (China)
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Questionnaire
Statement
1. To recall your wisdom easily and completely, we will record our
discussion in the process of the interview.
2. All information you provided will remain strictly confidential, will not be
disclosed in any form to any other organization and will be used for no
other purpose than academic research.
3. You are quite busy, your cooperation is greatly appreciated, and your
participation is greatly helpful.
4. As a return, as far as we can now, but far from what we intend to, you
and your firm will be listed on the contributor list of my dissertation.
Some of the results could be shared. Further contact with us is available,
and welcomed.
5. In order not to affect your opinion, we strongly suggest you not try to see
the hided words; this part is just an addition to your argument.
Time limit: 20 – 25 minutes
Questions:
1. Would you please describe the progress of your company’s presence in
China? (i.e. when and how did you start your business in China? a
representative office or a joint venture? What about now?)
2. Why did you decide to present your company in CHINA?
3. Why did you decide to start your business in CHINA with a form of
(i.e. joint venture or what else)? In other words, what are the main
considerations for this decision?
169
4. If you had made some change of the original form of market entrance (for
example, from a representative office to a wholly owned venture), what are
the reasons for such a decision?
5. The following will discuss some details about the entry mode choice
decision:
§ When you made your choice of entry mode in China, how have you
thought about the risk of this market?
(A)Very risky (B) Medially risky (C) Not risky (D) Don’t know
Have you changed your attitude now?
§ When you made your original choice of mode of entry into China,
how attractive do you evaluate this market for your products?
(A) Highly (B) Medially (C) Not (D) Don’t know
How do you think about it now?
§ When you made your original choice of entry mode, how favorable
do you think about the income tax rates in China?
(A) Very (B) Medially (C) Not (D) Don’t know
How about it now?
§ When you made your original choice of entry mode into China, how
do you think about the production cost in CHINA?
(A) Very low (B) Medially low (C) Not low (D) Don’t know
How do you think about it now?
§ When you decided to enter into China with a mode of , how do
you think about the transaction costs with CHINA?
(A) Very high (B) Medially high (C) Not high (D) Don’t know
How do you think it now?
§ Which one did you concern more in the process of entry mode choice
decision, production costs or transaction costs?
6. What role do you think the decision maker plays in the process of entry
mode decision? Important or not so important?
7. Have you tried to avoid any risk in the process of entry mode decision?
8. Does the board of directors or your boss set you an annual minimum profit
requirement? If yes,
170
1) how much have you considered about this profit requirement in your
process of entry mode decision?
2) without the profit requirement, should you had invested a little bit more?
9. Advanced technology and know how are critical to a firm’s success. Is there
any consideration of technology or know-how in your choice of entry mode?
For example, technology protection, technology transmission, and so on.
10. How do you like to make a joint venture with a local firm?
11. Have you followed some predefined process to make your entry mode
decision?
12. Have you met some difficulties of communicating with your Chinese
partners?
171
Curriculum Vitae
Xuemin Zhao
Date & Place of Birth: 3rd Nov. 1974 in NingYang, China, PRC
Education 16. 12. 2005 Defense on dissertation 04. 2002 – 12. 2005 Ph.D. student in Microeconomics, management, marketing
Bielefeld Graduate School of Economics and Management
at Bielefeld University
09. 1997 – 03. 2000 Postgraduate student in Enterprises administration
Tianjin Polytechnic University
09. 1993 – 07. 1995 College student in Textiles engineering and foreign trade
Tianjin Polytechnic University
Profession
08. 2005 – Now Thiel Logistics AG
04. 2000 – 03. 2002 Xiamen XiangYu Group, China PRC
07. 1995 – 09. 1997 Mahualong (ChaoYang) Textile Co. Ltd, China PRC
